While it has always been our feeling is that it’s worth paying a fee if you are getting a benefit from doing so, we also feel strongly that you should know what that cost is without needing to hire an attorney to read the fine print (which is where many of these are hidden).
Let’s start there—the fine print. While you will always find information on potential costs listed in prospectus documents, advisory brochures, and other disclosure forms firms are obligated to send to you; that’s actually a catch-all. Technically, it’s your advisor’s job to disclose everything up front, before you decide to invest or to move that account. This is something that, in our experience, sometimes gets “forgotten”—and it’s a big problem for clients. If they’re not open about it, you should wonder whether the relationship is right for you.
We think it would be helpful to have a few highlights of what to be aware of. For starters, all mutual fund investments have an internal cost. It doesn’t matter whether you have no-load index funds or a 401(k). There is always an internal expense ratio that you may not find on your statement. This will range depending on how actively managed the fund is, but could be anywhere from a fraction of a percent up to a couple percent. This cost is ongoing and it represents the internal costs for that fund manager to purchase and sell securities inside your fund. I’m going to have a future article on active versus passive management, but suffice it to say that lower costs aren’t always better.
You may also see costs for making trades. If you work with a commissioned advisor, or if you trade on your own, this is common—and remember that it’s on top of the internal costs. Basically, every time you purchase a security there’s a sales charge—generally of a few percent of the dollar amount of the purchase, and usually a smaller amount depending on how large the purchase is or how much you already have invested with a specific company (called rights of accumulation). The advisor may get paid for each transaction, which can lead to conflicts of interest (is your account just rebalancing for your benefit or for your advisor’s). You might also find ticket charges (usually $5-$15 per trade, whether buying or selling). We don’t like this format, so The Krajniak Group avoids commission sales, with the vast majority of our book on an advisory fee schedule instead.
Advisory fees are generally seen as a percentage of assets under management. Most advisors tend to be somewhere in the 0.5%-2.5% range. We make it a point to reduce the percentage as your account size grows, since managing a large portfolio takes roughly the same amount of work as a small one. Advisory fees are a fair way to make sure that you are receiving professional help and dedicated attention, and at a cost that is self-explanatory and less subject to conflicts of interest. The key here is the word “advisory.” If you are not receiving ongoing advice, then you are paying for a service you are not receiving. All of our clients are financial planning clients, which goes beyond the regulatory definition of advice on your investments. We conduct periodic reviews and have a written process to make sure we are helping you to track what we accomplish and to plan for the future. If you’ve done a review with us recently, you’ll have seen an email or a letter afterwards documenting what we talked about, and listing action items going forward.
Wrapping up, there may also be back end charges (or contingent deferred sales charges—CDSCs). This is common with annuities, which have surrender schedules for early withdrawals. You’ll see financial planning fees as well. These tend to be flat fees or hourly charges, with the idea that you are paying for the advice only—and no conflict of interests as your advisor is not assisting you with the implementation. The downside, of course, is the $1,000-$10,000 average price tag. We offer this service to our clients as well, but most prefer the advisory setup since our planning is included. Incidentally, many advisors don’t include planning with advisory accounts, or at least aren’t very thorough, so watch for “stacking” of different fees that may not be in your best interests.
In the end, you’re always going to pay something. All structures can be fair, but you should always be aware of what yours looks like. I read an article in the Wall Street Journal a couple months back that talked about how the financial services industry is remarkably resilient with finding ways to make money. Apparently regardless of how fees have changed over time, if you work with a company to do your investing, you’re going to average between 1%-2% of your money going to fees. The important part, then, would be to decide the most appropriate structure for what you’re trying to accomplish. Do you need long-term investments that you can’t sell without triggering taxes? Are you getting ongoing professional advice? Good professional money managers aren’t influenced by emotional decisions and can help keep you on track, but if you don’t have a good working relationship with them then it’s not helpful. We speak Prospectus, so always feel free to ask us if you have questions on what you are paying your advisor!