Analyzing the 'high-fee' DFA-approved advisor's sales pitch.

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This article was first posted March 1, 2007.

Invest with DFA Funds, 12-Step Program

This month Retire Early updates the July 2007 article on low-cost, fixed-fee DFA advisors. DFA funds have an excellent reputation, but are only offered to clients of DFA-approved financial advisors.

If you go shopping for a DFA-approved advisor, you'll find a wide range of fees for this service. DFA advisors follow two basic models in assessing their portfolio management fees; a fixed annual fee that more or less correlates to the amount of time the advisor spends on the account, or a percentage of the assets under management (AUM) where the annual fee increases with the growth in value even if the amount of time the advisor needs to devote to the account does not. There are also two versions of the AUM model; 1) a straight percentage of the total account value, and 2) a tiered fee structure where the first dollar in the account is assessed a higher fee than the last. The table below illustrates the difference.

Table One. Comparison of straight AUM vs. tiered AUM fees for a $2 million account.
-		AUM (Straight percentage)			-	AUM (Tiered)
Account Range	Fee (% of assets)	Amount ($)	Calculation	Subtotal	-	Amount	Calculation	Subtotal
up to $200,000	1.00%	--	--	--	-	$200,000	$200,000 x 0.01	$2,000
$200,001 to $500,000	0.75%	--	--	--	-	$300,000	$300,000 x 0.0075	$2,250
$500,001 to $1,000,000	0.50%	--	--	--	-	$500,000	$500,000 x 0.0050	$2,500
$1,000,001 to $5,000,000	0.40%	$2,000,000	$2,000,000 x 0.0040	$8,000	-	$1,000,000	$1,000,000 x 0.0040	$4,000
$5,000,001 to $10,000,000	0.25%	--	--	--	-	--	--	--
more than $10,000,000	0.10%	--	--	--	-	--	--	--
Total Annual Fee	.			$8,000	-	.		$10,750

To examine the range of fees charged by DFA advisors, the SEC disclosure database was used to collect information on the firms in the table below. Firm size (i.e., Assets Under Management (AUM) and number of clients) was obtained from the latest SEC Form ADV on file. The schedule of fees was obtained from either the Form ADV or the firms' website.

Table Two. Comparison of DFA-approved advisor fees
.		Firm Size		.	Annual Advisor's Fee Size of Client Portfolio
Firm Name	Location	Assets Under Management ($ MM)	No. of Clients	Minimum Account Size	$1MM	$2MM	$5MM	$10MM
Cardiff Park Advisors	Cardiff by the Sea, CA	$109	290	None	$1,200-$3600 fixed fee for portfolio of any size
Evanson Asset Management	Carmel, CA	$1,793	2140	$1,000,000	$2,000-$4,000 fixed fee for portfolio of any size
Epiphany Investors	San Rafael, CA	$25	9	$150,000 suggested minimum	$3,000 fixed fee for portfolio of any size
Portfolio Solutions	Troy, MI	$781	467	None (Minimum Fee $2,000)	$2,500	$5,000	$12,500	$20,000
AssetBuilder, Inc.	Plano, TX	$29	69	$50,000	$3,000	$6,000	$12,500	$25,000
Altruist Financial Advisors	Holland, MI	$69	25	$2,000,000	$10,000	$10,000	$14,600	$20,100
Merriman Capital Management	Seattle, WA	$1,316	5500	$100,000	$7,500	$10,000	$17,500	$30,000
Index Funds Advisors	Irvine, CA	$703	1970	$100,000	$8,250	$14,250	$26,250	$39,230
Buckingham Asset Management see Note(1)	St. Louis, MO	$1,620	3647	None (Minimum Fee: $3,500)	$9,000	$16,000	$25,000	$40,000
Edelman Financial Services	Fairfax, VA	$1,801	8329	$75,000	$14,000	$21,500	$41,000	$71,000
Note(1): Buckingham Asset Management informed us that they will be filing a new SEC Form ADV with a lower fee schedule in the near future. The table above has been revised to reflect these lower fees.

If you're not careful, you could wind up paying tens of thousands of dollars for a few hours of the advisor's time. Assessing a client's risk tolerance and allocating a portfolio across 10 to 15 index funds should take a few hours at most for a competent advisor. Occasional rebalancing and tax-loss harvesting, perhaps an hour or two per year. Even a fixed-fee DFA advisor charging $2,000 per year could effectively be billing you $400 to $500 per hour for his time. That's more than you'd pay an attorney or CPA in most areas.

For larger portfolios (say $5 million to $10 million), the most expensive DFA advisors charge annual fees in the range of $25,000 to $70,000. At this level, they'd really need to be providing you with a hundred hours or more per year of high-end, professional investment counseling and financial planning to make this look reasonable. If you can't get a good picture of what additional services they are providing, the man-hours associated with that activity, and who's actually doing the work (i.e., the advisor himself or the clerical staff), you're probably getting hosed.

Over an investor's lifetime, a high-fee DFA advisor can capture a sizable portion of the client's assets for his own account. The chart below compares the cumulative fee collected over a 30-year period for the six largest DFA advisors (in terms of client assets under management) examined. The most expensive collected over $1 million more in fees than the least expensive firm on the list.

To perform this analysis, the DFA advisors' management fee was deducted from the account quarterly. For fixed fee advisors, an annual fee in the middle of the stated range was assumed (e.g., $3,000 per year for Evanson Asset Management) This fixed annual fee was then indexed for inflation by 3% per annum over the 30-year period. If you want to do your own analysis on a DFA advisor's fees, here's an Excel spreadsheet use can use. Click here.

[DFA Advisor fees]
Note: March 7, 2008 The chart above was revised to reflect Buckingham's new, lower fee schedule. The 30-year cumulative fee dropped from $861,328 to $813,375.

Because of the effects of compounding, each dollar in fees that your DFA-approved advisor siphons from your account results in a $3 or $4 reduction in the value of your account over 30 years (assuming a 10% annualized investment return.) As the chart below illustrates, while there was only a $1 million difference in the cumulative fees collected between the highest and lowest cost advisor, the account value at the end of 30 years for the highest fee advisor was $3.6 million less than the account value for the lowest fee advisor.

[DFA Advisor fees]
Note: March 7, 2008 The chart above was revised to reflect Buckingham's new, lower fee schedule. The 30-year value of the portfolio improved from from $14,219,586 to $14,276,642.

Are "high fee" DFA-approved advisors smarter than their lower cost competitors? Do they produce higher investment returns?

Probably not. First of all, (as the chart above shows) a high fee produces a significant reduction the size of the client's account over 30 years. The $500,000 to $1 million in additional fees that a high-fee advisor siphons from the account creates a significant headwind to overcome just to get back to where you'd be with a low-fee advisor. Remember, while the advisor's fee is guaranteed by contract, the promise of superior results are not.

An advisor's ability to extract an outsized fee from a client is more of a testament to his sales, marketing, and self-promotion skills than any superior investment acumen. To a large extent, a DFA-approved advisor's investment return is produced by the proprietary quantitative techniques employed by Dimension Fund Advisors in stock selection and managing the fund, and adherance to the Fama-French Three Factor Model in portfolio allocation (i.e., wide diversification with overweighing in small-cap and value equities.) While you'll find variations between advisors in the recommended asset allocation for a given risk tolerance, a recent paper from Duke University showed that no advisor can reliably predict the exact asset allocation that will produce a higher return for the next year.

Analyzing the "high fee" DFA-approved advisor's sales pitch

Low cost, fixed-fee DFA-approved advisors simply sell their services based on the cost savings. For high fee DFA-advisors, it's a bit more complicated -- especially if the potential client has any feel for the small amount of time it takes for a competent professional to assess risk tolerance and allocate a portfolio across 10 to 15 index funds.

Most high-fee DFA advisors will first pitch a client with a "superior service" argument. Kind of like the way a high cost, full-service brokerage firm says it will "watch your money" a lot more carefully than a low-cost provider like the Vanguard Group. When that doesn't work, the pitch usually reverts to a time-tested fear appeal. Here are a few of the talking points:

A low-fee DFA advisor might not understand investing -- That may be true, but there are also "high fee" DFA-approved advisors who don't understand investing. Just because the advisor can extract a higher fee from the client doesn't mean he has more investment acumen.

A low-fee DFA advisor might not properly assess your risk tolerance -- An advisor can only base your risk tolerance on the information you provide them. Most will have some kind of questionaire for you to fill out. The competent ones will point out that many novice investors overestimate their risk tolerance.

A low-fee DFA advisor might not form a 'personal relationship' with you -- It's true that a low-fee advisor won't spend as much time with you. He likely won't offer you free tickets to a concert or ball game, or take you out to dinner. But when you look at the half-million dollar difference in fees over 30 years, that free dinner may well be your most expensive meal of the year.

A low-fee DFA advisor might not use an "all-DFA" portfolio -- Since DFA doesn't have the best performing fund in every asset class, there are a lot of DFA-approved advisors who don't recommend a 100% DFA portfolio to their clients. Indeed, an advisor who just blindly puts everything into DFA funds without first investigating to see if there is a better performing alternative for each asset class probably isn't doing a good job for his clients.

A low-fee DFA advisor might not do as good job at tax loss harvesting -- One high-fee advisor on the list, Buckingham Asset Management advertises their willingness to manage a portfolio of individual bonds at no additional cost. This allows them to take advantage of tax loss harvesting at the individual bond level. Is this enough of an advantage to offset Buckingham's much higher fees? Let's investigate.

For example, for a client with a $5 million portfolio, there is a $22,000 per year difference between Buckingham's annual fee of $25,000 and the $3,000 charged by a fixed-fee advisor. If we assume the client has a 50% allocation to fixed income ($2,500,000), he would be paying between $2,750 and $4,750 in mutual fund management fees, depending on the fund. (Vanguard's Short-Term Bond ETF (BSV) has an expense ratio of 0.11%, DFA's One-Year Fixed Income Fund DFIHX has an expense ratio of 0.18%, while the DFA Two-Year Global Fixed Income Index DFGFX has an expense ratio of 0.19%.) Of course, a portfolio of individual bonds would incur brokerage commissons and the additional costs of the bid/asked spread on each transaction. These costs probably offset the savings in bond fund management expenses. For a taxpayer in the top Federal bracket, short term gains are taxed at 35% and long-term gains are taxed at 15%. That means Buckingham would have to generate somewhere between $63,000 and $147,000 in tax losses to net the client a $22,000 annual savings on his tax return (depending on whether it's a long-term or short-term loss.) Could Buckingham deliver the $22,000 in annual tax savings required to absorb its higher fees with any regularity? I'm skeptical.

A low-fee DFA-approved advisor might not give you the kind of quarterly report you like -- DFA-approved advisors do differ in the detail and quality of their reporting. It's certainly reasonable to review this as part of your investment advisor selection process. But it probably doesn't make sense to spend an additional $500,000 to $1 million in fees over 30 years just because you don't like the font size on an account statement.

A low-fee DFA-approved advisor might skimp on office staff, equipment, and amenities -- Good point. No doubt low fee advisors don't provide free donuts and coffee for the staff and rent space in a Class B building. For the more important stuff, like whether or not the advisor has errors & ommissions insurance or an off-site place to store back-up copies of his records (as the SEC requires), you can easily ask to see the Certificate of Coverage for his policy or the name of the firm that stores his records.

A low-fee advisor might not help you with your estate planning or taxes -- That may be, but on say a $5 million account, the almost $40,000 difference in annual fees between the lowest cost and highest cost advisor would allow you to hire a high-powered estate attorney or CPA on your own if you need them.

What to conclude from this analysis?

The wide range of fees charged by DFA-approved advisors offers potential clients considerable opportunity for savings. Especially for investors with larger accounts, the assets under management (AUM) fee model appears to result in an annual charge that's wildly inflated given the small number of man-hours required to manage a portfolio of 10 to 15 index funds. If a "high-fee" DFA-approved advisor can't give you a detailed description for what additional services he'll be providing for the tens of thousands of dollars in additional annual fees, it may make sense to hire one of his low-cost, fixed-fee competitors.

Additional resources for further information --

Bogleheads Investment Forum (March 03, 2008): Comparing DFA money management fees
http://www.diehards.org/forum/viewtopic.php?t=14001

My Money Blog (March 2006): DFA Funds: The Porsche of Index Funds
http://www.mymoneyblog.com/archives/2006/03/dfa_funds_the_p_1.html

Forbes Magazine (10/30/2006): The Index Insurgents
http://www.forbes.com/forbes/2006/1030/064.html

Index Funds Advisors: The High Cost Of Low-Fee Advisors -- A high-fee DFA advisor uses the "fear appeal" to defends his fees.
http://www.cheapadvisor.com/

Evanson Asset Management: Fees and Services -- A low, fixed-fee DFA advisor explains why the high-fee guys are wrong.
http://www.evansonasset.com/index.cfm?Page=11

Financial Advisor Magazine (Oct 2002) DFA Advisors Clean Up.
http://www.fa-mag.com/past_issues.php?id_content=3&idArticle=753&idPastIssue=64

Financial Advisor Magazine (Mar 2001) Going Their Own Way.
http://www.fa-mag.com/past_issues.php?idArticle=227&idPastIssue=45

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