One of the hardest things to keep track of when it comes to paying for financial services is the fees. Unfortunately, they’re also a crucial part of how well your investments perform, which makes it worth your while to understand what exactly you’re paying to invest your money, when you’re paying it, and how it’s being charged to you.
These are the fees that you pay to your advisor and should be the easiest to understand and keep track of. Your advisor should tell you up front exactly what they charge – whether it’s a flat annual fee or a percent of assets charged at certain intervals (quarterly, semi-annually, annually). They should confirm this when you sign your contract (and it should be noted in the contract). This fee is likely one of the larger fees that you’ll pay, which is why you should give it considerable scrutiny. The difference between paying 1% and 2% on your assets may not feel like much, but over time the difference is significant (I won’t bore you with the math, but trust me – it’s a lot). If you’re paying 2% or more for professional management of your assets, your advisor should be doing an exceptional job for you. If they’re not, it may be time to look elsewhere because that 2% isn’t all you’re paying.
These are the fees that we often forget about when we’re not actively involved in managing our own portfolios, but they also play an important role in performance. Most custodians (Schwab, Fidelity, E-Trade, etc.) charge a fee for trading most funds and stocks (unless you use certain investments that they offer in-house that either trade for less or trade for free). If, for example, that fee is $25 that means that every time your advisor adds a new fund they pay $25. To make room for the new fund they may also sell an old fund, which cost another $25. If your advisor makes 20 trades in a year that’s $500 a year that you’re paying in transaction costs alone and that doesn’t include the fees that the funds themselves are charging you.
In addition to what your advisor charges and what you pay to trade, the fund manager also takes a bite off the top in the form of a fund fee. Unlike the fee your advisor charges and your transaction fees, which should both be available to you either in the form of a bill/statement or on your client portal, fund fees are much harder to see because they’re charged as part of the fund’s performance so you never really see them leave. This means that if the manager of your fund made you 7% this year, you only see 6% because he took 1% (or more or less) for himself. Fund fees are a good topic to ask your advisor about because a good advisor should be mindful of what the funds they’re choosing for you are charging and if the performance of that fund justifies the fee. Additionally, funds that follow an index typically have a much lower fee, making them a cheap alternative.
Commissions are a type of fee charged by brokers. As a Registered Investment Advisor this fee is not applicable to our firm and others like it because our clients use us as an alternative to using a broker, however, it’s important to recognize that brokers are compensated for what they sell in the form of commissions, which can consequently misalign their interests and yours.
It may seem silly to include taxes, but taxes can also be considered a type of fee on your account, in that you pay taxes on returns in a taxable account. A good advisor should be mindful of this and create value for you by pursuing a tax-efficient strategy that helps maximize returns while minimizing taxes leaving you with more in your account at the end of the day.
(This article was originally published June 16, 2016, on our sister site The Cupcake Club).