Many advisors shoulder the responsibility of supervising financial independence planning for their clients. What I’m curious about is whether or not they take cost or method of payment into consideration when putting together those projections.

I have two concerns.

Firstly, do advisors think about cost? For instance, if the asset classes comprising a balanced portfolio have a historical long-term real return of 5% and the portfolio the client is invested in costs 2.25%, are advisors planning on a 5% real annual compound annual growth rate (CAGR) or a 2.75% real CAGR? William F. Sharpe’s paper, “The Arithmetic of Active Management” suggests that one ought to assume a return equal to the benchmark minus the cost of the product (i.e. the latter).

Secondly, when completing your independence calculations, is consideration given to whether or not the client pays for the advice from within the plan or outside it? Obviously, the cost is essentially the same in dollar terms, although there may be other considerations such as tax deductibility at play. For instance, let’s assume a client has a $500,000 portfolio and pays the advisor 1% on assets for related advice ($5,000/ year). If the annual fee payment is taken from within the account, the account’s value would drop to $495,000. Conversely, if paid outside the account, it would still be worth $500,000. If this account was an RRSP, that would allow for an additional $5,000 of tax deferred compounding- and that’s only for one year! The difference could be staggering come retirement.

I might add this is a significant benefit for clients who have maximized their RRSP contributions. As it now stands, there are laws preventing people from putting more than $22,450 into an RRSP in any given year. There are no laws to prevent people from minimizing the leakage due to what is taken out while the account is open.

Obviously, if a client uses unbundled products that cost (say) 1.25% and then pays an additional 1% fee outside the plan, the leakage problem is reduced, but not eliminated. In the interest of full disclosure, I should add that this is what I do. I use returns similar to historical benchmarks weighted by the asset allocation of the portfolio, make no reductions for product cost and then charge my fee outside the account.

One might call it a “split the difference” approach to planning.

As all readers will know, the combined costs of products and advice could sum to anywhere between 1.25% and 3.25%. The number I used in my example was just something I believe to be close to the mid-point. My approach is a simple one. No matter what assumptions you are using when helping your clients to plan for their retirement, there’s a reasonable chance that you are significantly overstating the likely long-term return if you are not taking the costs of products and advice into consideration.

Rather than being alarmist, let me invite readers to check out the impact for themselves. If you are not currently taking the combined costs of advice and products into account when doing your planning, please come up with reasonable assumptions of what those two things cost and then re-run your clients’ financial independence projections.

I dare say some serious conversations might ensue after you learn the results. Then, comes the hard part. If you really want to be a STANDUP (Scientific Testing And Necessary Disclosure Underpin Professionalism) advisor, you’ll likely have to come up with a way to honourably disclose the revised model to your clients.

John De Goey, CFP, is the vice president of Burgeonvest Bick Securities Limited (BBSL) and author of The Professional Financial Advisor II. The views expressed are not necessarily shared by BBSL. You can learn more about John at his Web site: