If you work with a financial advisor, you can be billed in several different ways. Two of the most common bases of payment are transactions and assets under management. However, there are many other investment-related fees go beyond these basic forms of payment. Unfortunately, many individuals do not know what they are paying.
A recent CFA Institute survey examining the state of investor trust, included improving transparency and clarity regarding fees, security, and conflicts of interest as one of 8 Steps to Increasing Credibility and Professionalism in the financial services industry.
It is important that investors and clients truly know and understand what fees they are paying. A 2017 survey by Cerulli Associates found that more than 40% of investors either did not know what they were paying for advice or they thought it was free.
Similarly, a 2017 survey conducted by Harris Poll for Personal Capital showed that 61% of Americans do not know how much they are paying in investment fees.
This data results from the considerable lack of transparency there is in the financial services industry related to fees. It also can result in the misconception that those working with commission-based advisors are not paying any fees unless there are transactions in their account. To understand why this is not the case, let’s examine the different types of fees investors may be charged.
Understanding Investment Fee Types
1. Front-Load Sales Charge
An up-front commission charged when you buy certain funds. If you are not sure if such a fee applies, ask, “if I buy this investment today and want to sell it tomorrow, what will I get back?” If the answer (beyond any fluctuation in the share price) is not “all your money,” the difference is likely upfront fees and commissions.
For example, if you pay $10,000 to buy a fund with a 5% sales charge, the value of your investment immediately falls to $9,500. In other words, if the investment returns 5.25% in the first year you own it, you will end up about even.
2. 12b-1 Marketing Fee
This represents an annual commission ranging from 0.25% to 1.00% annually. It is a fee for marketing or advertising. It also includes trailer commissions paid to the broker of record as an incentive to sell the fund. It works like an annuity for the sales person during the time you own the fund.
3. Transaction Fees
Every time you buy or sell a fund, individual equity, bond, or other similar asset, a fee is typically paid to a custodian. These can range from $1 to hundreds of dollars per transaction.
4. Ongoing Advisory Fees
These represent monthly, quarterly, or annual fees you pay advisors for their investment advice and oversight. These services include determining the appropriate asset allocation/diversification, selecting investments, tax optimization, rebalancing, and other periodic tasks. Some advisors may also include fees for financial planning, budgeting, and other related services as part of the ongoing advisory fee.
If you don’t know how much your advisor charges, you can check the firm’s Form ADV. You can find Apprise Wealth Management’s ADV here.
5. Additional fees for services
Ask what specifically is included in the advisor fee. Not all advisors will properly disclose additional fees for financial planning or ancillary services. Services can range from minimal assistance only focused on your investments to providing comprehensive, holistic financial planning. It is important to know what is and what is not included in your advisor fee.
6. Ongoing fees charged by the managers of specific funds or investment products
These fees, which can also be referred to as the fund’s expense ratio, come out of the fund’s assets. They represent one of the hardest fees for investors to find. Only the most transparent advisor or salesperson will disclose such fees. They are not shown on your brokerage statements or your advisor’s invoices. The only way to know the amount of this fee is to read the prospectus, ask your advisor about it, or review a third-party analysis of the investment, such as one provided by Morningstar.
7. Miscellaneous Fees
These fees are rarely talked about and hard to find. Some advisors charge a fee of $50 or $100 a year per account, or they may charge to close an account. There can even be additional fees charged to dollar cost average your funds into the market.
What Can Investors Do to Manage Investment Fees?
Consider working with a fiduciary. Brokers are only required to do what is suitable for their clients. Brokers have latitude to engage in transactions that are best for the broker (e.g., make him or her the most money) even if they are not what is best for the client. On the other hand, fiduciaries are required to put their clients’ interests ahead of their own.
How Do You Know if Someone is a Fiduciary?
Here are some ways you can answer this question.
You can review the advisor’s professional credentials. The following professionals are required to put a client’s interests first and act as fiduciaries:
CPAs who work as financial advisors; and
You can also ask. No one should lie about it.
If the person works for a registered investment advisor, they are required to act as a fiduciary. You can also check their Form ADV Part 2, which is available on the SEC’s website.
The advisor is also required to give you a copy of his/her ADV before you become a client.
Some Questions You Can Ask
- How are you compensated?
- Do you work for a fee, a commission, or both?
- Do I pay you, or are you paid based upon what I invest my money in? For example, annuities, mutual funds, stocks, bonds, alternative investments.
- Are you a Registered Investment Advisor representative?
- What professional designations do you hold?
Note that these are essentially “yes” or “no” or closed-end questions. No long answers are required.
Where Else You Can Look for Information?
can also look up the advisor on FINRA’s BrokerCheck website. After putting in their name, see if it says “B – Broker Regulated by FINRA,” it means they are only held to the lesser suitability standard (meaning they can put their interest ahead of yours if their recommendation is at least suitable for you). If it says “IA – Investment Advisor,” then the individual is a fiduciary who must always do what is in your best interest. If it says “PR – Previously Registered Broker,” they used to be a broker. Now they are either retired, no longer working as an advisor, or are now a fiduciary.
If the Number of Transactions in My Account is Low, Should I Use a Fee-Only Advisor?
A question that often comes up is, “If I am just a buy-and-hold investor, is it better to work with someone that is compensated through commissions, so that I will pay less?” The answer? It depends. If you think back to the beginning of this post, we may recall that a large percentage of investors do not know the total costs associated with their investments. I have come across people who believe that since they are not paying their advisor directly, they are not paying anything. However, this is rarely the case. After accounting for fees such as fund expense ratios, investors that think they are paying their advisors nothing will find that they are paying considerably more than they thought.
When Can It Make Sense to Work With a Commission-Based Advisor
While Apprise is a fee-only firm, other fee structures were considered when the firm was formed. We recognize that there are times when working with someone that only charges commissions can make sense. For example, consider the following:
· You have a legacy stock position that represents a meaningful portion of your portfolio.
· You have a significant portion of your portfolio in company stock that you do not wish to or cannot liquidate.
· You hold significant positions in stock with low basis that you do not intend to sell because of the associated tax cost.
· You are in the late stages of your life, you anticipate outliving your money, and expect some of your low-basis stock will be transferred to your heirs after you pass away. As a result, their basis will be “stepped up” to fair market value.
Of course, holding large positions in a single stock can have other negative implications related to your portfolio’s diversification and risk profile. To minimize the associated risk, options can be used to hedge your position, which can be a valuable service. Your advisor could also agree to not charge a fee on assets such as those described above as they may not be actively managed.
Working with a Commission-Based Advisor Can Cost More Than You Think
If your advisor buys funds with upfront charges, 12b-1 fees and/or the funds have relatively high expense ratios, you could pay a lot more. For example, if your portfolio includes fund with annual expense ratio of 1.50% or more, then you will likely pay more in fees than you would when working with a fee-only, fiduciary investment advisor, especially if that advisor includes low-cost exchange traded funds (EFTs) or individual stocks as part of your portfolio.
If you want services beyond investment management, it is also important to understand what you will be charged for those services. Such services are important, but they may also come at a cost. On the other hand, some firms do not charge for such services. For example, at Apprise Wealth Management, for accounts above $500,000, holistic financial planning and related services are generally included in your asset-based fee. Some firms may charge significantly more for such services.
Why We Believe Working With a Fee-Only Advisor Is the Best Option
At Apprise, we think the fee-only, fiduciary approach is best. Expenses matter. We know the expense ratio associated with any mutual fund or ETF held in client accounts. Similarly, we know the commission that is charged to buy or sell such assets. When considering costs, all these elements are considered and communicated to our clients and prospects. We also maintain the flexibility to exclude assets from the fee calculation where applicable. In addition, where appropriate, we may work with clients on an hourly basis.
Fees matter. They can destroy investment returns. Paying higher fees does not necessarily translate into better returns. We know that deciding to work with an advisor will impact your returns. Fees are not inherently bad, however. Many financial advisors will include other services at no additional cost; e.g., insurance and financial and estate-planning advice. If you believe your advisor is truly earning his or her fee, then it can absolutely be money well spent.
At the same time, be careful of paying excessive fees. Do not pay an advisor 1.50% of your assets when you can find someone providing comparable services for less. Be wary of investing in a mutual fund with an expense ratio of, for example, 0.75%, when there are similar products that accomplish the same objective at a materially lower cost.
Lowering your investment fees allows more profits to stay in your investment account, which can have an impressive compound effect on returns over time. Whether you are choosing your 401(k) investments, looking for a financial advisor, or thinking about investing in mutual funds, stocks, or ETFs on your own, the fees you pay should be an important factor in your decision-making process.
If you would like to talk to us about your investments or creating a financial plan, please fill out our contact form, and we will be in touch.
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Phil Weiss founded Apprise Wealth Management. He started his financial services career in 1987 working as a tax professional for Deloitte & Touche. For the past 25+ years, he has worked extensively in the areas of financial planning and investment management. Phil is both a CFA charterholder and a CPA.
Located just north of Baltimore, Apprise works with clients face-to-face locally and can also work virtually regardless of location.