Frank (name changed), a 68-year-old retired electrical engineer, knew he was paying something. He just know exactly what. So he sought to move to another advisor and get some answers.
Why he never asked in the first place is beyond me; frankly, it was beyond him too. I’m not sure what brought it up, but he finally asked the question: “How much am I paying on my investment accounts?”
Frank had about $290,000 in a few separate, managed portfolios. It consisted of mostly mutual funds and ETFs. It turns out he was paying roughly $5,500 per year in advisory fees; not sure if he was more upset or embarrassed.
Either way he knew that he would be paying something. But, wanting to confirm, he asked his advisor: “Are there any other hidden fees that I should be aware of?” The advisor responded: “No, there are no additional fees.” That’s when he entered my office.
As I mentioned, had three separate accounts, two which the advisor was charging 1.5%. The other account, which was a managed ETF portfolio, was being charged 2%. He asked me the same question. Without looking, my initial thought was: “If you have mutual funds or ETFs, there is going to be some sort of internal expense.” But, I wanted to be careful because you don’t know until you know.
When he handed over his first statement it didn’t take long to learn that he, in fact, was paying more than the 1.5% that the advisor was charging. It was a mutual fund platform that I was very familiar with since it was one that was used in my previous brokerage firm quite commonly amongst the advisors there.
We have a few different mutual fund screening software programs that we use and I pulled up one to show him what the internal expense of the mutual fund was. The internal management fee of the fund was 2.04%.
At first Frank was silent but he kept thinking what the advisor told him. He then, with somewhat positive reassurance, said, “Well, at least it’s only about a half a percent more than what I thought. That’s not so bad.”
I explained to him the 2.04% was in addition to the 1.5% that he was paying the advisor for a total fee of 3.54% just on this one account (the rest of the funds in this account were also in the 2.0% range).
You would have thought that I punched his firstborn square in the mouth.
I wish I could say that this was an isolated incident, that this only happens on seldom occasions, but unfortunately it doesn’t. It happens quite often. Time and time again we come across investors that are paying exorbitant fees in their portfolios. And even worse, that they’re often paying 2% to 3% more.
But the question is, why? They feel outrageous when they aren’t appropriate for the service you need or when you don’t know about the fees in the first place.
Benjamin Brandt, a certified financial planner at RetirementStartsTodayRadio.com dives into the first point, “Rather than focusing on the fee amount, I would first question the structure of the fee. The clients should want the advisor’s incentives to align with their own. As an example, if a client is looking for advice on short-term goals (debt management, business appraisal, life insurance), a one-time fee would be more appropriate than an ongoing fee. If, on the other hand, a client needed an ongoing retirement income plan, a recurring plan-based fee might be more appropriate. Once the appropriate fee-style is determined, cost comparisons can be made. Oh, and anytime an advisor says their products don’t have fees . . . run!“
Grant Bledsoe, CFA, President of Three Oaks Capital Management at 3OaksCapital.com points out a great way to help get at the truth about fees, “I had someone ask me recently, ‘Are there any fees I’ll incur in my account that you don’t invoice me for directly?’ I think this is a good way to phrase the question since it encompasses loads, commissions, expense ratios, 12b-1 fees, and anything else that comes out of the account.”
Unfortunately, many people are blissfully unaware of the fees they are paying in their investment accounts.
A survey commissioned by Rebalance IRA showed that out of their sample of full-time employed baby boomers, 46 percent believed that they do not pay any fees whatsoever in their retirement accounts. Moreover, those who believe their fees are less than 0.5 percent total 19 percent. Yikes!
Jude H. Wilson, founder of Wilson Group Financial at WilsonGroupFinancial.com talks about this unawareness, “For most of us, a larger portion of our investments are held in mutual funds within our 401(k). I tend to find people regard their mutual funds as a free service provided by their company’s retirement plan and not as for-profit. They tend not to look at it the same way as hiring an attorney, a plumber, or an accountant.
Yes, mutual funds are in the business of making money for you but they’re also in business to make money for themselves, the investment company. Like any other company, they have overhead. For them to be profitable revenues have to exceed expenses. So the questions all investors should ask themselves are: what are you paying for, is it reasonable, and are you positioned for the highest probability to get a return on your investment in the long run?”
The unawareness of fees is unfortunate.
When consumers step into an ice-cream shop, the prices are clearly stated on the menu. Sometimes, they are even heavily advertised as “deals” and are made available right next to the cones, cups, and sundaes listed.
This is certainly not the case with many financial firms. Should they boldly state their fees on a banner in the office? That might seem a little weird. But should they clearly disclose their fees before the client signs on the dotted line? Absolutely.
Additionally, some financial advisors steer their clients toward “suitable” investments, but not necessarily the “best” investments. A rule emerging from the Labor Department, the “fiduciary rule,” is aiming to ensure financial advisors must act in the best interest of their clients.
Advisors can help their clients understand their fees. And, they should. Ronn Yaish, CEO and Wealth Advisor of Yaish Financial at YaishFinancial.com explains what he recommends to financial advisors, “I would suggest a ‘show me rather than tell me’ approach to better understanding fees. It behooves the advisor to educate both the client and prospective client.
There are many ways a financial professional can go about this education. One way is to provide a one-pager clearly detailing the advisor’s fee, trading, and operating and management expenses of the respective mutual funds and ETFs. Along with this one-pager visual aid, I suggest explaining each fee and expense along with the rationale for having this investment plan in the first place. It is important for clients to be informed and understand the why, what and how behind their investments.
Some individuals prefer examples or case studies to provide context to understanding fees and expenses. I myself prefer learning from case studies rather than dry textbooks or 100 pages of academic research. So too, I find prospective clients appreciate learning from a case study approach to illustrate clearly their “take home,” aka their returns net of fees.
Advisors are leery of using past performance when educating a prospective client because past performance may not imply future performance. But in this situation, when the objective is not about “selling” a security but rather giving an opportunity to demonstrate a lesson regarding fees, an exception may be made.
The advisor can develop a sample portfolio using the prospective client’s investment and risk profile. Once this fictitious portfolio is established and the advisor runs the numbers for the previous year, the advisor will show the impact of each layer of expense such as operations, investment management, trading, and advisor’s fees.”
How can you find out how much you’re paying?
As an investor, you can find out how much money you’re paying in fees by finding a firm that will clearly reveal them with your statements. Joseph A. Carbone, Jr., Managing Partner of Focus Planning Group at FocusPlanningGroup.net offers his perspective, “One of the easiest ways to make sure all fees are transparent and upfront is to find a firm that sends out an invoice for the fees that were deducted from their accounts. For example, if the firm bills quarterly, make sure the firm sends you a separate invoice with how much was deducted from your respective account(s).
Keep in mind this is in addition to the custodial statements that show a line item with the Investment Advisory fees deducted from the account. Too often clients never look for that line item and it is very hard to find. I also would encourage clients to work with a firm that bills monthly. At my firm, we bill monthly and we send out a monthly invoice with investment advisory fees deducted from each of their accounts we are managing. Quite frankly it is just easier to understand and more importantly, the client knows what to expect.
Financial advisors should already be transparent about the costs associated with their services, including the internal costs of the investments themselves. Investors have a right to understand how and what they’re paying. While this is common sense, investors are best advised to research before investing.
It’s best to know where to begin when figuring out your fees. “Start by asking your advisor exactly how they get paid,” says Scott Wellens, a certified financial planner with Fortress Planning Group at FortressPlanningGroup.com and the host of the “Best in Wealth” podcast. “There are three models under which advisors get paid. Some advisors get paid strictly on a fee-only basis, which means they get paid directly from the client and never from the mutual fund company or insurance company. Fee-only is a straightforward model for consumers to understand.
The fee may come in the form of an hourly fee or as a percentage of assets under management. Other advisors work under a commissions model, which means they do get paid directly from the mutual fund or insurance companies for selling financial products. This model is not as easy to understand as a fee-only model. Do not confuse fee-only with fee-based. A company working on a fee-based model means they may be collecting commissions and charging the clients directly. Expenses can add up for consumers under the fee-based model.”
Know what you are paying.
Ask your advisor what your “all in” cost is for investing. Make sure to uncover any additional fees the mutual funds or ETFs might earn. If they say there are no hidden fees, verify.
You can verify through a third party. For example, if you own a mutual fund, you can simply enter the five-letter symbol into Yahoo Finance to find out its internal expense. Sites like FeeX.com and Morningstar.com will also give you management fees.
Finally, double-check your statements. If you’re paying an advisor fee it should be on your statement. You might have to hunt for it, but it’s there.
When it comes to your investments, you can discover the truth about the fees you’re paying. Take matters into your own hands!