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Rick Ferri: Advisor Fees Are ‘Last Bastion of Gluttony’ in Investment Industry

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“If your incentive is to get paid, the way you’re paid will determine subconsciously the advice you provide,” argues Rick Ferri, founder and CEO of Ferri Investment Solutions, in an interview with ThinkAdvisor. “Incentives drive advice — always have.” 

Ferri, 63, who was a financial advisor for 32 years, is attempting to influence new, young FAs to separate advice-giving from portfolio management in structuring their compensation. In other words: Don’t charge a fee — like the prevalent 1% — based on assets under management.

“It’s a conflict of interest for an advisor to provide both advice and portfolio management,” Ferri asserts.

In the interview, he discusses what he sees as fairer alternatives.

The chartered financial analyst and fiduciary is a consultant to both individual investors and, under a separate umbrella, to advisors. He charges each $450 an hour.

Index fund-oriented, he gives advice chiefly to do-it-yourself investors seeking confirmation as to whether they’ve been managing their portfolios well; and he helps pre-retirees with distribution planning.

Ferri’s interview podcast, “Bogleheads on Investing” — supported by the nonprofit John C. Bogle Center for Financial Literacy —  garners 30,000 downloads a month.

For investor clients, he provides what he calls “financial planning lite,” but which nonetheless includes substantial tax and estate planning guidance.

He started as a broker at Kidder Peabody, later moving to Smith Barney when Jamie Dimon was president.

He founded RIA Portfolio Solutions in 1999, selling the firm to an equity investor 18 years later, in 2017, and forming Rick Ferri LLC. Two years after that, he launched Ferri Investment Solutions.

ThinkAdvisor recently interviewed the candid consultant, who was speaking by phone from his Georgetown, Texas, base.

He argued that advisors should not be entitled to a percentage of gains made in a client’s portfolio, just as a CPA isn’t entitled to part of a client’s tax refund.

He then discussed “the last bastion of gluttony in the investment industry,” followed by his forecast for active managers’ performance (think actively managed ETFs).

Here are highlights of our interview:

THINKADVISOR: By calling for advisors to unbundle advice from portfolio management, are you fighting a one-person battle?

RICK FERRI: No. There are a lot of other people saying this, a whole network trying to evolve the industry; we’re not trying to change it.

You can’t change the advisors who are charging 1% and those who are doing commission business.

But a lot of them are going to eventually get less business because of the evolution in how advisors charge. 

You say it’s a conflict of interest to both provide advice and sell product, and provide asset management services. Why is that a conflict?

If your incentive is to get paid, the way you’re paid will determine subconsciously the advice you provide. If you’re selecting a product you get paid a commission on, for example, your recommendation to the client will be to your own benefit.

You’re going to convince the client one way or another to do what’s in your best interest. That’s where the conflict comes in. Incentives drive advice — always have.

Do you think advisors are charging fairly for their services?

Most are charging way too much. This is the last bastion of gluttony in the investment industry.

For years, I managed a portfolio for a quarter of a percent, and we had a 30% profit margin. 

How in the world advisors in good conscience charge clients 1% or 1.5% per year for literally the same thing is beyond me. 

If they have a client with a million-dollar 401(k) rollover and charge them $10,000 a year to manage that portfolio and charge another client with a $2 million portfolio $20,000 if they roll over, what is the advisor doing differently? The answer is absolutely nothing. 

And if the $1 million portfolio grows because the market grows, now the advisor will get paid $20,000. Why should they get paid $10,000 more a year because of that? The answer is, they shouldn’t.

Are you trying to convince most advisors to unbundle their fees? 

I know I’m not going to turn a 1% AUM advisor into an hourly advisor or a fixed-fee advisor charging an annual $8,000 or $9,000 to manage money and give advice regardless [of] how much the client has.

I’m trying to influence the new, younger advisors who haven’t yet decided how they’re going to structure their compensation. Charging 1% AUM is not the way to do it. 

What’s the better way?

More on this topic

Charging an hourly fee or a subscription where the client pays a small monthly amount for ongoing advice as they need it, or a flat fee, regardless of how much money they have, if you’re going to do advice plus portfolio management.

A lot of advisors are doing that now — charging a flat quarterly or annual fee and giving the client unlimited advice.

What do AUM- and commission-based advisors say in objecting to your views?

They try to justify their fee: “You have to measure the value we add” and “We’re entitled to a portion of that value added — what we do makes money for the client, so we’re entitled to a portion of that money,” they say.

But that’s not true. An advisor is like a CPA: They do your tax return but aren’t entitled to a portion of your refund [if you get one]. Advisors aren’t entitled to a percentage of the financial benefits the client gains from the portfolio.

What do you propose, then?

The way you solve the problem with the advisor who does quote-unquote money management and advice is to charge a flat annual or quarterly fee or even a monthly fee. And it doesn’t change based on the amount of money the advisor is managing.

The first track is complete separation between the advisor who’s giving the advice and the advisor who’s managing the portfolio. The advice-giver gets paid an hourly fee or a retainer or subscription.

The second solution, if an advisor is doing both advice and portfolio management, is that you have to structure the compensation so that regardless of the advice they give, they get paid the same amount of money. 

You can do a flat family fee of $8,000 or $9,000 a year.

What else do you think is wrong with the way advisors handle their fees? 

A fiduciary advisor has a legal responsibility to review costs in a client’s portfolio every single year. But they’ll skip over their own fee whenever they come to it. They won’t address their own fee ever.

If the client complains about the fee, the first thing the advisor will say is, “That’s the industry standard,” which is nonsense.

There’s no such thing as a standard fee. That might be the average fee, but it’s not the standard, because there’s no standard fee in the industry.

If the client argues some more and the advisor thinks they’re going to lose the client, they’ll give them a break and reduce their fee somewhat. 

But no advisor is ever going to come to the client and say, “You know, we’ve decided that 1% is too high now, and we’re going to reduce our fee.”

When they seek you out, what do investors need help with most?

No. 1, they come with a very complicated portfolio, most of the time put together by an advisor, and they want to make it simpler: They might have 25 to 50 funds that are really a mess, and they want to consolidate that into a few good low-cost funds.

Why else do they come to you?

For validation or confirmation that they have a good portfolio they’ve been self-managing. They want confirmation that they’re doing it right.

The third thing is when people are getting ready to retire, they want to make sure they’ll be distributing their money well — whether they should be doing IRA Roth conversions, when to take Social Security — and how it all integrates into a distribution plan, including how to pass the money on to the next generation.

Is promoting index funds part of the advice you give?

I’ll make a recommendation. If the client is at Fidelity, there are Fidelity index funds they could use. If they’re at Schwab, they might use Schwab index funds. If they’re at Vanguard, they could use Vanguard funds. 

Or it could be a mix-and-match — whatever makes sense for the client. You can buy Vanguard ETFs through Fidelity or Schwab.

Where do you see active management headed?

The big thing right now is that active management has figured out ways to create actively managed ETFs and distribute their product through them.

This has helped drive down the cost of active management because the cost of running an ETF is less expensive than the cost of running a mutual fund.

An ETF saves active investors money, and that helps cut underperformance. So active management fees have been coming down, and ETFs are helping that.

Do you think that active managers’ performance will improve?

It’s feasible that active management will do a little better relative to the indices going forward.

But on the flip side, you’ve got some really smart people that are going into active management. The quality of management has gotten a lot better over the last 25 years. So the competition has gone up, which makes it tougher.

(Photo credit: Kristin Gladney)