Here are a few questions I have to ask you.
- Do you have investments?
- Do you have a 401(k), IRA, or another retirement savings plan?
- Do you own a non-retirement brokerage account with stocks, bonds, or mutual funds?
If you said yes to any of these, you’re paying somebody to manage your money. The financial institutions managing your money are not doing it for free.
Any reasonable person would expect to pay something to somebody for the service. Knowing this, a logical question might be, “How much am I paying, and what am I getting for it?”
Unfortunately many Americans have very little understanding of the fees that they are charged by the financial institutions that hold their assets. A recent financial news article printed findings from a study in which Americans knew more about the fees charged by their entertainment streaming companies like Netflix than they do about the fees charged by their employer’s 401(k).
“Out of sight, out of mind” is perhaps to blame for why so many are uninformed about the fees they pay on their investments. Let’s bring them back into view, shall we?
Fees on your 401(k):
A typical 401(K) will have fees for plan administrative functions, including record keeping, accounting, legal, and trustee services. These types of fees are often deducted from plan participant assets (AKA: your money). In addition to administrative charges, as a plan participant you will likely incur investment related expenses that are hard to spot.
Fund options within the plan have fees associated with them to cover management of the fund, and marketing expenses. These fees are often referred to as annual operating expenses. They are similar to the expense charged by publicly available mutual funds.
Depending on the plan options, some of the funds available within the plan may have a ticker symbol that makes it easy to research details online. The ability to search the web for your investment option’s ticker symbol makes it easier to identify the expenses charged by the fund for management and advertising.
Some 401(k) plans may use proprietary investment options that are not available to the public. They are not so easily found with a web search. This can make the fund more difficult to research, and fees more difficult to identify. However, the plan document governing your employer’s plan should identify these funds and the annual expenses charged on your retirement dollars allocated to the investment options.
These annual operating expenses are not deducted from the plan assets. They are however deducted from the assets within the investment fund. Therefore, they won’t show up on your 401(k) statement making it hard to identify the total annual cost of your 401(k). Nevertheless, they are very real and often costly even if you don’t see them.
Considering the facts, there’s no wonder why so many participants are clueless about how much their 401(k) is really costing them each and every year.
Fees On Brokerage Accounts:
It’s likely that if you are the owner of brokerage account you will find several potential fees associated with ownership and management. If you are working with an advisor it’s likely that person is charging a fee to manage the account. The fees paid for investment advice can range from advisor to advisor. However, a fee based fiduciary investment advisor is required by law to fully disclose all fees and conflicts of interest. Therefore, this fee is usually known and information readily available.
If you are working with a commissioned broker instead of a fee based investment advisor, he may not be charging you a fee for his advice. In fact, that may even be a selling point made by the broker soliciting your business. “I’m saving you money by not charging you’re a fee for advice,” might be the pitch. However, you have got to wonder, “how does he get paid?”
Commissioned brokers receive compensation from selling various investments. It may come as a surprise to you to learn that they are not always required to act in you best interest. As long as the product that they have sold is “suitable” they could sell you an investment product that pays a higher commission even if there’s a similar and potentially better investment product for you that pays a smaller commission.
Depending on what investments your advisor is recommending for your account, there may be transaction costs. The transaction costs are expenses for buying and selling investments within the brokerage account. If your account experiences high turnover of the investments, and your advisor is buying and selling frequently, seemingly small transaction cost could add up to big money.
Your advisor may also recommend investments such as mutual funds, ETFs or other investments that carry annual operating expenses. The annual operating expenses are fees charged to the investment fund and don’t show up on your statement. This makes it more difficult for you as the account owner to appreciate the real annual cost of the investment account. These fees can add up to thousands if not tens of thousands of dollars annually in addition to the fee you may be paying your advisor.
Mutual Funds and ETF:
Mutual funds and ETFs are a basket of investments typically managed by something or someone. Although they may appear similar, ETFs are traded on the open market like stocks, but mutual funds are not.
Mutual funds are available in various share classes. The share classes are primarily differentiated by how the investor pays to own them. For example, an “A” share of a mutual fund would be expected to have a front-end load, or fee, in addition to an annual operating expense. For example, if you buy an “A” share of the Growth and Income fund from ABC Investment Company with a 5% load and a 0.75% annual operating expense your initial investment is reduced by 5% (the load), and then you money is charged an annual expense of 0.75%.
On the other hand, a “C” share of the same mutual fund would be expected to have a higher annual operating expense, but no front end load. For example, if you buy a “C” share of the Growth and Income fund there’s no upfront load, but you can expect to pay a 1.95% annual operating expense. Your entire initial investment is invested, but then your money is charged an annual expense of 1.95%.
Often times ETFs will have lower operating costs than mutual funds, but both mutual funds and ETFs are likely to have expense ratios that may surprise many investors.
The expenses ratios on mutual funds and ETFs can be found online if you know where to look. They may range anywhere from a few tenths of one percent to well over 2% annually.
These operating expenses are applied in addition to the fee charged by an advisor for investment advice.
It is common for many to overlook their total annual portfolio expense. Simply failing to add the funds expense ratios to the cost of investment advice will grossly misrepresent your annual investment expenses.
When an investment advisor is recommending mutual funds or ETFs within a fee based investment account the total annual cost to the account owner can be surprising.
Variable Annuities:
Variable annuities are insurance contracts. Registered representatives of broker dealers often sell them. The broker dealer and their registered representatives earn a commission based on how much money you invest in the product.
Variable annuities have insurance related costs in addition to investment related expenses. For example, mortality and expense charges (M&E) and administrative charges are common fees found on variable annuities. It is common to see M&E charges of 1% or more, and administrative fees of 15 tenths of a percent (0.15%). These charges are deducted annually for the life of the contract.
Many contracts offer optional riders with additional income or death benefit features. The riders often come with an annual expense. The rider fees can vary, but many such as income benefit riders exceed 1% annually.
All of the contract fees may be located within the variable annuity prospectus. However, these documents can be upwards of several hundred pages deep, and filled with hard to understand legal language. It can difficult for many advisors to fully comprehend what they are selling let alone investors like you to navigate what you are buying.
In addition to M&E, Admin, and rider charges there are investment options within the annuity called subaccounts. They also have net annual operating expenses like the mutual funds discussed earlier.
A subaccount within a variable annuity may be similar to a mutual fund outside of a variable annuity. The subaccount’s net operating expense may be similar as well. However, sometimes the variable annuity subaccount expenses are even higher than comparable mutual funds outside the annuity.
Paying Fees Is OK, but….
It’s OK to pay fees. After all, you’re going to pay somebody to manage your money. No one worth his or her expertise will do it for free. If they are providing value to you it is worth the cost. The question may be, “What do you consider valuable?”
- A comprehensive written plan and maintenance of that plan
- Advice on financial decisions related and unrelated to investing
- Strategies to reduce taxes, order or returns risk and other retirement risks
- Competitive investment returns during an up market
- Active management that seeks to potentially reduce losses during a downturn by making decisions when to exit and enter the market
………and so on, then it may be worth the cost. If you don’t get any of these services, it may not be worth the cost.
On the other hand, if the advice is free it may not be that great. Remember, you get what you pay for.
Understanding how much you’re paying, whom you’re paying it to, and what you’re getting for it are all things to consider before making any financial decisions.
You should get enough value to justify the fees you are paying, and be satisfied with it. If you’re not satisfied with the services that you’re receiving, then you must ask yourself, “why am I paying these fees to who I am paying them to?”