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  • Writer's pictureNEXT LEVEL money

The Michelin Star Recipe Portfolio (A Story About Fees)

Would you rather go to a 3 star rated Michelin restaurant and have the chef cook you a fabulous meal or would you rather be given the chef's exact recipe (for free), but have to recreate the dish yourself in your own kitchen? All else being equal, probably be served by the chef. The problem is it's not all else being equal. There's this thing called cost. Let's say the cost of the meal is $120, but if you bought all the ingredients at the grocery story and made it yourself, the cost would only be $30. Why is the cost so much higher at the restaurant? Because what you are really paying for is service - the experience of going out and being served and not doing the work yourself.

Now some adventurous, creative or otherwise penny-pinching individuals would much rather do the work themselves and recreate the dish on their own time from the recipe. But probably because they already enjoy cooking, have the time and knowledge to make complex gourmet recipes, and like the idea of saving money.

I'm giving away my secret sauce for free. The recipe to build your own investment portfolio. But it still takes work to manage a portfolio. Sometimes paying the extra cost for the service is worth it. Not everyone enjoys investing or has the time or knowledge to manage their own portfolio.

In the restaurant world a ~300% premium is a reasonable price to pay for the service you get. But in the investment world, you may have to pay a much higher premium.

Here's the math: If you pay a 1% management fee and the portfolio's underlying expense ratio is 0.2%, your total fee is 1.2% (a 1.2% total fee is relatively cheap for a <$1M portfolio. In past companies I've worked for closer to 2% is more common). My portfolio currently has an underlying expense ratio of ~0.03% and the management fee is 0.00% because I manage it myself. So instead of paying a ~300% premium as you would at a restaurant, you're paying a ~3000% premium to hire an investment adviser. Now is that worth it to you? Maybe it is because you don't have the time, interest or knowledge to manage your own portfolio. Just be warned how expensive it really is. A 1.2% fee on a $1M portfolio is $12,000 a year. At that price your could go out for the $120 meal twice per week all year round.

To add injury to insult there's no way to make sure that your not overpaying for the service. Not all investment advisers are the same. Sometimes you get subpar performance from them. You could do better by buying a Vanguard index fund and calling it a day. Going back to the restaurant analogy, it's one thing to pay $120 for one of the best meals you've ever eaten. But it's another thing to pay $120 and only get a McDonalds burger.

(Side note: I love the McDonalds dollar menu, but I love it because it's a great value and convenient for road trip stops, not because it's the best food ever.)

If you are a DIY-er, then you can use someone else's instructions and do-it-yourself for great results AND low cost. To me, that's the best of both worlds.

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