How Much is That Doggy in the Window?
By Brad Thomason, CPA
If you offer something attractive to a child and ask do you want to buy this, the child will say Yes.
If you offer something attractive to an adult and ask do you want to buy this, the adult will ask how much it costs.
Note that persons below a particular age can and do act like adults. Note too, that persons far above a particular age may act like children.
(Despite the fact that this would be a great jumping off point to discuss the politics of many progressive initiatives, that's not where we're headed. Not a political blog, after all. We'll stay in our lane. But the similarity is interesting. Anyway…)
Many people find the idea of hiring an investment advisor attractive. They will say that they like the idea of guidance and expert input. In actuality it is frequently the case that what they like best is the idea of handing off an unattractive task to someone else (I have people to take care of that sort of thing…); and maybe setting the stage to have someone to blame if things don't go well.
There are lots of reasons to be your own chief financial counsel. I have addressed these elsewhere and am not going to try to cover them all again here. Instead I'll just focus on one aspect: monetary cost. Frankly, it may be more than reason enough.
Many advisors set their fees based on the size of your portfolio. A standard approach is to charge 1% of "assets under management."
If a 50 year-old with $800,000 asks How much is this going to cost, the advisor will answer - truthfully - $8,000.
Eight grand doesn't sound like so much to pay for a better shot at a successful retirement.
The problem though is that $8,000 is the one-year cost, not the full cost. Remember, retirement is a decades-long discussion. Not to mention the fact that hiring the pro may not actually increase your odds of success, in the first place. But I digress.
Let's do some quick math (which means that if you take the time to do the actual math you'll discover that my short-cuts actually understate the full cost; but they are easier to follow and I think they'll make the broader point, just the same).
From age 50 to age 60, with some modest appreciation, total fees paid could end up around $125,000. Even with no growth, $8,000 a year for a decade is eighty grand, so that’s not such a huge estimate…
Let's assume you decide to take over at 60, and there are no more fees paid out (otherwise, this is going to get ridiculous; although plenty of financial firm clients are over the age of 60, for sure). The $125,000 you paid out is not there to compound. Had it been, when you retired at 70, it could quite plausibly have grown to be $250,000.
If you retired at 70 with the sort of money we're talking about, it could well be another ten or even fifteen years before you got around to spending this hypothetical portion of your portfolio (which, again, you don't have, because it went to fund your advisor's retirement instead of yours). Maybe twenty.
In that time, even accounting for a serious down-shift in rate of return (because you wisely reduced your risk exposure after having won the game of properly endowing your retirement), it could double again.
How much does that advisor in the window cost? $8,000? Yes. $500,000? Quite feasibly, yes again.
Attractive things can become automatic possessions when someone else is paying the tab. That's why ten-year olds don't have to ask for the price. But I suspect you are neither ten, nor in a situation where another person is underwriting the tab for your wants.
By Brad Thomason, CPA
Would it ever be necessary for you to invest any money for retirement?
Arguably, it wouldn't.
In the above scenario you would essentially stockpile the equivalent of 50 more years of spending while paying for the 50 years of your working life. Since, from age 70, you are almost assured to not live longer than another 50 years (at least based on what we know about aging and longevity, today) then you would have enough money to pay for your life without taking on any risk of loss from investing.
Now, obviously the world described above is not the one we are living in. But the creation of the artificial conditions serves to focus attention on the very particular question of why we invest in the first place.
The implicit definition of investment that is being used here is something like 'letting someone else use your capital, in exchange for a fee, with the possibility that the capital might be lost.'
Why would a person expose themselves to such a risk if it were unnecessary?
If we change the parameters around and it becomes clear that the person won't be able to stockpile all of those future years of spending simply from the sum of savings alone, then it becomes obvious why the person would invest. Without the addition of the investment earnings to the saved capital, there will be a shortfall in funding at some point in the future. At least there will be if the person lives long enough.
So the reason for the risk in that situation is pretty obvious.
But what if that's not the case though? What does that say about the logic of investing?
Keep in mind here, too, that the options are not a) be an investor, or b) put your money in the mattress. The significant qualifier of the definition above is that the capital might be lost as a result of putting it to use. So the person could take advantage of interest earning opportunities at banks or insurance companies, where there are legal guarantees, and the mandated financial infrastructure to back up those guarantees. That wouldn't qualify as the type of investing being discussed here. Even if such earnings don't do anything eye-popping with the account balances down through the years, they still serve to ward off some of the effects of inflation; the absence of which was the most unrealistic of the what-ifs listed above (FACT: I know more than one business owner who lives on somewhere around a third of the annual take, saving the other two-thirds for later. So the bit about saving a substantial portion of your yearly take-home was the least unrealistic of the what-ifs. At least, relatively speaking).
If you succeed in amassing a large enough nest egg - most likely through the combination of saving and at-risk investing - you will awake one morning to find that you may not need to continue with your investing program any further. You may have enough to carry the exercise (i.e. living) out as far as you'll need to. When that day comes, you may find yourself asking just what it is that justifies the ongoing risk. And if you think you are likely to ask such a question and have trouble answering it, then it makes sense to go ahead and spend some time thinking about the moves you will want to make, before that day actually arrives.
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