In this simple article I am going to cover one way you can help your investments perform better. Avoiding high fees.
Your Financial Advisor is a good place to start looking for high fees.
If you have hired a Registered Investment Advisor, often called "Financial Advisor" or RIA, then this individual should have your best interest in mind. This means being as transparent as possible with ALL fees and using good judgment when fees are needed.
Unfortunately I want to go over a few fees that I have seen far too often that have little or no merit. If you see any of these fees, please ask your Advisor about them and be sure to ask.... "Why?"
Four types of fees.
1. Up Front Fees.
2. High Fee Investments, 12b-1 and deferred charges.
3. Advisor Fees.
4. Activity Fees or Churn.
1. Never pay "Up Front"
Money removed up front is never invested. Money lost to this type of fee can not participate in failure or success. This can be a diverse group of fees but all are 100% losses to you.
Never pay up front to open an account. Brokerages, like Scottrade and others, do not charge to open accounts and neither should your Advisor. In fact, if you ask, most brokerages will give you incentives to move your account into their care. They will even reimburse transfer fees in many cases and award free trades.
Some Advisory firms, even 'fee only' firms, charge their base fee up-front. RIA's do have rules about this and it can not exceed a certain amount or time frame, unless it has detailed disclosure. These fees create a feeling of commitment in the client. Leaving an Advisor with this fee often requires a confrontation to recover the fees. RIA's are required to return these fees to clients on a pro rata basis at the end of services provided.
Advisor's fees should be charged a reasonable time after services are provided.
More Up-Front Fees
Advisors often use mutual funds with more up-front fees. Here is an example from Franklin Templeton.
Yes, these can be as high as 5.75% as shown above. This has the same effect as the base fee from an Advisor but is often much higher and is IN ADDITION to the other fees. Remember this means if you make a $100 per month contribution to your advisor and something like this is in your account then you get $94.25 invested in the fund (and still get to pay the other fund fees and advisor fees).
A simple review of your account will tell you right away if these funds are being used. A part of these fees are often returned to the Advisory firm as compensation for choosing the fund, these funds are very tempting to the Advisor in terms of the Advisor getting paid.
I find these fees the most offensive because better decisions can easily be made for the client.
2. High Fee funds, with 12b-1 fees and sales charges
There is a case heading to the Supreme Court right now that addresses this issue..... "Did your Advisor choose the best priced fund for you?" Link to case here. Lower cost funds should be chosen for you if they are available, funds should at least be competitive.
If you could chose between three S&P500 funds then there is little doubt you would choose the lowest cost fund. Yes, I'm assuming equal reputation and safety of the assets.
It's very simple to look into this, note the expense ratio's below:
0.05% - Vanguard S&P500 Admiral (MUTF:VFIAX)
0.25% - USAA S&P500 Fund (MUTF:USSPX)
0.56% - Blackrock S&P500 (MDSRX)
I would question the use of funds with an expense ratio above the Vanguard Funds. These three companies are doing a good job with fees. Nothing wrong with Blackrock or USAA, but if your Advisor is using them, he needs to justify the additional expense and you should ask him for that answer.
Even worse is that some funds are disguised S&P 500 Funds, like the Franklin Templeton Growth Fund which states clearly in the prospectus that it is benchmarked to the SP500. Link here. This means that you could have an S&P500 Fund with a sales charge of 5.75%. Do you? Please check on that. Ask your Advisor why he didn't pick the Vanguard S&P500 fund for your account.
Many mutual funds allow for Advisor compensation to come from 'Wrap-fee' programs where the firm selecting the fund is compensated from the fund and thus from the client. These fees can be deferred sales charges and the annually charged 12b-1 fee.
In the example fund page above I circled the 12b-1 fee. This is a reoccurring charge and is often, but not always, shared by the brokerage and the Advisor. Investments are available with the same goals, risk and most of the same holdings as these high fee funds.
3. Advisors Fees, these should always be "fee only".
The shift to "fee only" advisory services is a good thing. But how much should this fee be?
Definition of Fee Only: The only revenue stream for the Advisor is from client Assets Under Management (or AUM for short) and is from a set percentage on an annual basis. No other fees go to the Advisor. Investopedia describes Fee Only Advisors here.
So an Advisor with a Fee-Only structure would charge like the example below, and NO OTHER FEES are available to the advisor from the client.
$100,000 in AUM at 0.75% = $750 per year in fees.
In fairness this AUM model needs to have some scale. The larger the account the lower the percentage should go. Advisor's should have a maximum of 1.0% for the smallest accounts, decisions should be carefully made as to the size of each account allowed to be under management. Accounts in the $500,000 dollar range should be 0.75% (or lower). Balances above that level should move down orderly to a fee around 0.35% for large accounts (or lower!).
If Mutual Funds are being used then the firm should charge on the low side of these rates. Mutual Funds and even Exchange Traded Funds represent some degree of external management of the account and should be evaluated in selection of an Advisor and in the evaluation of his fees.
4. Account Activity or Churn
The reasons and timing of account activity can vary widely and I would never question that. However, when mutual funds are sold it can trigger fees to the account via new sales charges and deferred charges. In these cases strong justification is needed for the changes. You should make note of activity in your account and make sure that substantive changes are made via the activity. This type of activity is called "churn", here is a link to the definition from Investopedia.
When I was starting my Advisory Firm I spoke with some advisors that have been doing it a long time. I found that these guys were sales people and do little, if any, management of assets. I found them to be honest and good people, but representing them as Investment Advisors was a big stretch in my mind. It is very important to be encouraged to save and to have goals. Many Advisors are skilled at this and it's needed work. However, too often the fees against client assets are hard to justify even with the addition of great coaching.
Like any investment you make, invest some time into the practices of your Advisor if you have one. It could boost your performance. I will be happy to do my best to answer specific questions, I will not be able to comment on strategies, investment types, risk level or timing from other Advisors. I will certainly look into the fees, all are welcome to look into mine.
Your 'all in' fees should be less than 1.25%. The days of higher fees are simply a thing of the past, this is a good thing. Information is free and abundant to those who know how to look. However, the very individuals that need this information most are the ones not able to find or understand it. These individuals are in need of the highest Fiduciary standards, and shame on any who take advantage of them.
Doug Meeks, RIA
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.