Column: The value versus cost problem of financial advice

Q: I have a financial planner with a major national bank. I have $685,000 with him. The high value for this account was $695,000. I recommended we add a stock to the portfolio and I made $15,000 on it. The problem is this: I am making about 3 to 4 percent. I am very conservatively invested, yet if win or I lose, he still gets 1 percent of the total investment.

So, in simple math, if a $700,000 account gets a 3 percent return, that is $21,000. His take will be $7,000, so I really get $14,000, or 2 percent. If I lose, he still gets his money. If I am getting 6 percent on a conservative investment, then OK, take 1 percent. But when I only am getting 3 percent, paying 1 percent is a third of the return.

So the question I have to ask is: What am I really getting out of this arrangement? I would like to know your thoughts. - R.B., by email

A: Good question. One of the unpleasant realities of investment management is that it is a low value-added business. That means it should be priced modestly, not extravagantly. Wall Street has been very slow to accept this reality because having an extravagantly priced service has been good for them, even if it isn't good for us. And they've been able to get away with a multitude of false claims and hoopla for decades.

Fortunately, people are finally asking questions. Money is flowing away from expensive management toward more reasonably priced management. So now let's take the other side of the question, because this is a two-way street.

You are absolutely correct when you say that your adviser gets paid even when it's a losing year. But your adviser has rent and overhead expenses to pay in good years and bad. Your adviser also bears some legal liability and can be sued at any time. So it's reasonable to ask: How much does he have to charge to pay the rent and assume those legal liabilities?

Answer: He has to charge something. It may not be 2 percent, it may not be 1 percent, but it has to be something, or he won't be able to make his Kia payments. This is why I have advocated the unbundling of financial services. Assets can be efficiently managed at costs under 0.10 to 0.20 percent by using low-cost exchange-traded index funds. Anything beyond that is about financial planning or, in some cases, hand holding. Both can be important, but they aren't equally needed by all people.

That puts the ball in your court. Just because you made one good stock pick doesn't make you a money manager. You might still benefit from some guidance in diversification, risk management and securities selection. You can get that as simply as buying a single mutual fund. Or you can pay someone who will explain things.

Just understand that the more you want explained, the more expensive the service should be. If it isn't expensive, your adviser is likely to 'fire” you as an unprofitable customer.

Sadly, most people aren't willing to do the learning necessary to live comfortably with low-cost investing.