How Advisors Kill Your Retirement Like The Walking Dead

Several friends have recently contacted me about their retirement accounts. They are planning to retire and want to rollover their 401k to an IRA. So far, so good.

While they managed their 401k for decades, however, they are uncomfortable managing the rollover IRA. The combination of a lot of money to manage and the consequences if they get it wrong makes them squeamish about investing on their own during their golden years.

So they wanted my view on the cost of hiring an investment advisor. The costs ranged from 1.5{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e} to 2.0{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e} of assets under management (called AUM in the business). Are these costs a big deal?

No. They are freaking huge deal.

Investment fees are always, always, always a big deal, but that’s never more true than when you retire. Let’s look at why they are so important, and then what you can do if you still want help managing your money.

The 4{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e} Rule

The general rule of thumb is that a retiree can safely withdrawal 4{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e} of their nest egg in the first year of retirement. With $1 million in retirement savings, for example, one could take out $40,000 in year one. Thereafter, the withdrawals could be increased each year to keep pace with inflation. Following this approach, studies have shown that a retiree following the 4{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e} strategy has a reasonably good chance of having her money last in retirement.

We’ve examined the 4{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e} rule before. You can listen to my interview with Maria Bruno and Colleen Jaconetti of Vanguard. We discussed the 4{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e} rule and alternatives in depth. I also recently wrote about the rule in my weekly Forbes column.

4{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e} – 2{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e} = The Walking Dead

The 4{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e} rule puts into sharp focus a 2{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e} advisory fee. And that reminds me of The Walking Dead. I’ve finally caught up to the current season. One part of the show I enjoy is how the Walkers sneak up on hapless victims. The Walkers are slow and make lots of noise, yet somehow there they are at just the wrong time. So it is with investment advisor fees.

Remember our $1 million portfolio above? It should be generating $40,000 a year in income. If we have to fork over 2{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e} to an investment advisor, however, $20,000 of our yearly income gets paid out to our advisor. Yes, the advisor takes 50{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e} of our annual income.

There are two possible effects, both of which are bad. First, you may just accept the smaller amount and live on less. Second, you may decide that you still need to generate $40,000 a year. If that’s the case, and given that you only get to keep 2{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e} of your yearly 4{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e} withdrawal, you will need a much larger retirement balance. To generate $40,000 a year with just 2{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e} you’ll need $2 million saved.

What if the Market Returns 10{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e}?

One response may be that you can take out more than 4{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e}. After all, the stock market returns on average 10{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e} a year. There are at least two problems with this strategy. First, while the market has returned 10{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e} on average (sorry Dave, it ain’t 12{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e}), in many years it returns less, including years where the return is negative.  Second, when the market does return more than 4{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e}, this amount must be reinvested to keep pace with inflation. The 4{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e} rule assumes that you’ll continue to invest any returns over this amount.

What About an Advisor Who Charges 1{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e}?

It’s true that not all advisors charge 1.5{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e} or more. Some charge around 1{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e}. That’s still not going to cut it. At 1{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e}, you’ll either need to accept $30,000 a year in our example rather than $40,000, or save a lot more. To generate $40,000 a year with a 3{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e} withdrawal rate (remember, 1{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e} goes to the Walking Dead) you’d need to save over $1.3 million.

What Are My Options?

You have several options if you still want help managing your retirement accounts.

First, you could use an automated investment service (called a robo advisor). These services provide tools that make investing a snap. They construct a portfolio for you, rebalance your investments, and automatically reinvest your dividends. Here are my top three choices:

• Betterment: This service charges some of the lowest fees in the business and offers beautiful tools to understand your investments.
• Wealth Front: For my money, Wealth Front offers an asset allocation model that is second to none.
• Future Advisors: This option is a tad more expensive (50 basis points), but you get access to a human advisor.

Second, you could hire Vanguard. The mutual fund giant offers investment advisor services for just 30 basis points. Why anybody would pay an investment advisor more I’ll never understand.

Third, you can use a combination of the above two approaches. There’s no rule that says this is all or nothing. In fact, if you do choose to hire an expensive Walking Dead advisor at 1{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e} or more, you don’t have to transfer 100{6fac3e6a3582a964f494389deded51e5db8d7156c3a7415ff659d1ae7a1be33e} of your assets to him or her.

The upshot of this is simple—Don’t let an advisor take a bite out of your retirement.

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