Pursuing financial independence is a marathon, not a sprint. You have to enjoy some of your wealth along the way, otherwise you risk burning out early. This post covers one way we have added a little luxury to the journey.
Investing fees matter
Investment books commonly hammer in the point that fees matter, since portfolio performance negatively correlates with investment fees. This means fees can erode an enormous amount of your wealth and force you to either save more or live on less. (see this post on how I slashed investment fees using the self-directed option in my 401(k)). The two types of fees you can control are investment fees and adviser fees.
Investment fees come in the form of loads (sales commissions), transaction costs (trade commissions), and management fees (which are reflected in fund expense ratios). Using low cost, passively-managed index funds minimizes all of these fees. Low cost index funds don’t have loads. Trade commissions are often low (or zero), depending on the investment platform you use; we have accounts with Vanguard and Schwab, and have never paid a trade commission. Finally, index funds have incredibly low expense ratios, often less than 0.1%. These are the reasons we exclusively invest in index funds for our securities (paper asset) holdings.
Financial adviser fees
If you have the time, interest, and ability to manage your own finances, you can achieve your target asset allocation with passive index funds. If you don’t want to DIY it, you have to pay a financial adviser. The financial adviser can extract their fees in three different ways: commissions (loads), assets under management (AUM) fees, and a flat fee (such as an hourly rate).
Stay away from commissioned “advisers.” They have a major conflict of interest, because what works best for them–selling high commission products–will almost certainly hurt your returns.
The AUM model at least aligns the interests of the adviser with the client, since the adviser makes more as the portfolio grows. For example, an adviser charging a 1% annual AUM fee wants to see your portfolio grow from $100k to $1M because they’ll get $10k per year from you instead of $1k. But the AUM structure also adds a lot of drag to your portfolio. To see this, it’s best to compare the AUM fee to your expected portfolio withdrawal rate; at face value a 1% AUM fee sounds small. For example, if you are planning a 4% portfolio withdrawal rate, the 1% AUM fee represents 25% of your withdrawal (1% / 4%). In other words, when you use an AUM adviser, you’re not only funding your retirement. You’re also funding your adviser’s retirement. For this reason, I would not use an AUM structure.
With the flat fee structure, you pay a fixed amount, such as an hourly rate, for the adviser to design and/or execute your financial plan. If I were going to use an adviser, this is the type I would use. The value is actually pretty good; a lifetime of flat fee advice probably costs the same as one year of AUM fees on a large portfolio. But I believe by reading a few books or taking a course, most people can successfully DIY their finances and save even more.
The wine-ancial adviser fee
For the reasons mentioned above, we manage our own finances. For compensation, we decided to spoil ourselves with a nice bottle of wine every time our net worth grows by $50k.
Since we are frugal and have mostly averted expensive taste, our typical bottle of wine runs in the $10-$15 range. But earlier this year we visited Sonoma, CA–of course using travel rewards–and found a winery that we love. The bottles cost $65 ($50 more than our base level), and we refuse to drink them aimlessly. By tethering the wine to our financial milestones, we have combined our appreciation for nice wine with our appreciation for saving and investing. This is our wine-ancial adviser fee, which is a one time “fee” of 0.1% ($50 wine upgrade / $50k net worth increase).
The wine-ancial adviser fee has the following benefits
- The incentives are aligned–we like to drink wine and we like to build our net worth.
- The one time “fee” of 0.1% is very reasonable. The graph below shows how the wine-ancial adviser fee compares to the cumulative 1% AUM fees on $50k invested over 30 years at a 6% rate of return (net of fees).
- Wine-ancial rhymes with financial.