Is it possible to make $665,000 a year and still struggle to pay your bills? For many highly compensated professionals, this is a sad reality. But how can this be? They did everything according to the book. They followed the supposed blueprint for success. They got good grades, went to college, got advanced degrees, and became doctors, lawyers, and accountants. They put their money away in 401(k)s or entrusted their money to financial advisers, but they still don’t feel like they’re getting ahead. So, what’s the problem?
Aside from the student loan burdens and the problems with overspending, the reason why many high-earners have a hard time building wealth and saving enough for retirement is because of who they’re entrusting their money to when investing. Letting someone else manage your money can come with a heavy cost if you’re putting your money in the wrong hands.
In a recent article about a surgeon who makes $665,000 a year but still feels broke, finance expert, Ramit Sethi, pointed out to the couple the dangers of financial adviser fees and other similar investment management fees. Jeff is a surgeon who makes $665,000 a year. He takes home $426,000 a year. Although Jeff makes a lot of money, he and his wife, Susan, also spend a lot of it. Their discretionary spending is high, and they have a hard time saying no to their kids.
Aside from Jeff and Susan’s spending issues, Sethi points out that one of their biggest problems has to do with their financial adviser, who charges a percentage of assets under management (AUM). This management fee isn’t exclusive to financial advisers. Mutual fund, ETF, and hedge fund managers all charge similar fees as a percentage of assets under management. These fees range from 0.25% to 2.5%. For example, the average mutual fund fee as a percentage of AUM is 1.1%.
In this case, Jeff and Susan have $460,000 in two brokerage accounts. Their financial adviser charges a fee of 1.24% of the AUM. If they live to age 85—for another 35 years—without making any further contributions to these accounts and assuming an average 5% return, that 1.24% fee adds up to a whopping $863,170, according to Sethi. For perspective, a 5% return reduced by the 1.24% return results in a net return of 3.76%. The average long-term US inflation rate is 3.28%. According to the math, Jeff and Susan’s portfolio makes a miniscule 48% annually when taking into account adviser fees and inflation.
The problem with these investment management fees is that most Americans aren’t even aware of them. Sure, they may appear in the year-end reports, but who really reads these documents? Even those aware of these 1-2% fees assume they’re just the normal cost of doing business. But if the fund or portfolio is only averaging a 5% annual return that is being eaten up by inflation and management fees, what’s left for retirement? Not much. It’s no surprise, then, that a majority of retirement-aged Americans feel financially unprepared for retirement.
If you look at an ultra-wealthy person’s portfolio or even institutional investors’ (i.e., family offices or university endowments), you won’t find equities, let alone managed equity accounts, at the top of their allocations. Instead, you’ll find real estate and investments in private companies (i.e., private equity or private investments) occupying 50% or more of their allocations.
So why do sophisticated investors prefer real estate and private investments?
ONE… these assets offer cash flow that stocks, mutual funds, ETFs, and hedge funds don’t offer. Those assets rely on appreciation for their returns. The cash flow element allows for the compounding of returns when reinvested, which public equity offerings can’t offer.
TWO… investing in these private assets takes their money out of the hands of advisers and managers, who eat up profits by taking a percentage of the assets under management, whether they make the investor money or not.
THREE… the returns from real estate and private investments not only outperform equities in the long run, but they do so at less risk. These returns easily outpace inflation, ensuring you keep a higher chunk of what you earn compared to returns from equities that barely keep pace with inflation.
Break Free…
- Don’t play the Wall Street game.
- Don’t settle for paying for management fees that will drain your wealth and prevent you from achieving your financial goals.
- Break away from tradition and mainstream assets and strategies.
- Take your hands out of Wall Street and their advisers and managers, who will drain your portfolio whether you make money or not.
To avoid being broke even if you make six figures, think of alternative cash-flowing assets like real estate or private investments.
