Is my financial adviser’s 1% fee normal, or am I being ripped off?

The financial adviser I used to work with moved on, and I’m looking for a new one. Someone recommended a financial adviser, so I looked into them. They were charging just over 1 per cent per year based on the value of the portfolio. I balked at the fee, but I don’t have much experience, since I was with my old adviser for a long time. Is the fee normal?

It’s not unusual for financial advisers to charge a percentage fee based on the total portfolio value. So, if the fee is 1 per cent and your portfolio is $500,000, you’ll pay $5000. This doesn’t change based on performance. Whether you lose or make money in any given year, you’ll still be paying that 1 per cent fee.

If you’re only looking for investment management, then 1 per cent could be too high. I’ll start by giving you a bit of context.

Historically, investing in the stock market meant you were mostly buying shares in a specific company – or you’d give your money to a fund to do that for you. The idea was that they were the experts who knew how to analyse, pick and manage stocks, getting you a ‘good return’.

What is a good return, though? As a benchmark, the average return of the stock market as a whole over the long term sits somewhere between 7 and 10 per cent. In the past, the value proposition of some funds was that they aimed to beat market returns.

However, research suggests that most people – including professionals– are not successful at beating the market average over the long term.

The real question is what are you paying for?

With this in mind, back in the ’70s index funds came into existence. The proposition was: we’re not going to attempt to beat the market, we’re just going to try and replicate it. Why put in all that extra effort to try to get above-market returns when the likelihood of doing so is slim anyway?

The benefit of this approach (nowadays known as ‘passive investing’) is that it requires less work. Index funds don’t need to be researching, analysing and picking specific stocks and then constantly monitoring them to decide if it’s time to sell or buy. They just try to replicate the market as a whole (or, to be specific, an index). It’s a copy-paste strategy.

This allows them to reduce costs. Unlike funds trying to pick stocks (known as ‘active investing’), index funds and ETFs that aim to replicate a broad market index don’t need to do all the extra research involved in stock-picking. Less work translates to lower costs.

To give you some estimates, if you were to totally DIY your investments (ie. sign up with a broker and buy them yourself), it would be possible to get your management fees to under 0.2 per cent.

If you were to sign up with an index fund or a robo-adviser, you might be looking at anywhere from 0.2 to 0.4 per cent. But let’s say you’re paying 0.5 per cent instead of 1 per cent on a portfolio of $500,000 that earns a 7 per cent return over 20 years – the total effect of fees on your portfolio would be about $183,000 (compared to $349,000 if you were paying 1 per cent). That’s a difference of over $166,000.

Now, I said the ‘total effect’ of fees is because the impact of fees is more than the fees you pay. Remember, you’re not just paying fees – the fees also reduce the total amount of money available to be invested, and that compounds over time.

For instance, 1 per cent of $500,000 is $5000 – but if you’re paying half of that ($2250), then that’s an extra $2250 that’s going to be invested. So, when you factor in this drag on portfolio growth, the total impact of fees ends up being much greater than just the sum paid.

Plus, there are other costs (such as taxes) you may pay as well. The more you pay in costs, the harder your investments have to work to make a good return net of costs.

All of that is to say there are significantly cheaper options if you’re only looking for portfolio management. So the real question is what are you paying for?

I don’t know enough about your situation. Maybe that firm is offering you additional services like estate planning. Perhaps you’re paying for the quality of relationship you have with that adviser.

Even if you’re getting good value, it’s worth asking whether it’s worth paying a percentage fee, where you’ll keep paying more every year your portfolio grows?

However, if you have a fairly vanilla portfolio of ETFs and a few shares, a fairly low-maintenance set-up without complicated structures (eg. trusts, companies etc), and you don’t need much ongoing advice, I’d question if you’re getting enough value to justify the premium.

Paridhi Jain is a money and mindset coach who combines practical strategies with mindset transformation to help clients create more freedom and fulfilment in wealth, work and life. Find Paridhi at: skilledsmart.com.au

• Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.

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