Do You Know Your Investment Costs?
Do you know your investment costs? If you buy a car, you know the price, right? What about your house? Your groceries? Since you know the price of just about every product and service you purchase, shouldn’t you know what you’re being charged for your investments? It really doesn’t matter whether you’re investing on your own or through a professional advisor. You, the investor, really should know exactly what you’re being charged, shouldn’t you?
Surprisingly, most investors really don’t know what they’re being charged, and by whom. Moreover, if you hire a professional advisor, shouldn’t he be explicit about everything he charges, as well as the commissions and fees of the products he’s selling to you? After all, isn’t he being paid to answer your questions and provide you with forthright information?
Forms of the Costs. Generally, investment costs come in three forms: fees, commissions and trading costs. Trading costs for stocks are what you see touted the most on television, but they’re typically the smallest of the investment costs. This is due to two things. First, almost all retail investors should be investing through some type of mutual fund to maximize their return for a given risk level. And second, since most investors are investing through mutual funds, stock trading fees are irrelevant to their situation.
Next, we need to recognize that the fee for the mutual fund comes in two pieces: the fee for the professional advisor, if you use one, and the fee the mutual fund charges. Because the investment industry has a strong lobby in Washington, you, the investor, usually never see either.
Typical Fees and Commissions. How much are these fees? Mutual fund companies charge, on average, 1.5 percent per year of your portfolio’s balance to manage your investment. Yes, the mutual fund companies should have to explicitly state their fees the way Campbell’s has to put the calorie count on their can of soup. However, again due to their strong lobby, the mutual fund companies split their costs into fragments and then bury the fragments in many pieces among the 200 page prospectus they have to send out every year, which is not written to be investor friendly.
If you’re using a professional advisor, they’re typically adding to the mutual fund fee in one of three ways. One way is to charge you an up front commission, which is typically 5 percent of your initial investment. The second way you may get charged is through an exit fee, which is often tied to how long you’ve held the investment. And the third way they may levy their charge is through an annual management fee, which is typically 1 percent, on top of the mutual fund’s annual 1.5 percent cost.
Incentives and Motives. Back on the mutual fund fee, do you think the mutual fund companies would ever funnel some of their 1.5 percent annual fee back to the professional advisor? Absolutely. They do it all the time. Such a kick back is called a “trailer”. Do you think such a kick-back would bias the professional advisor? Absolutely. Wouldn’t such a benefit bias you?
Another thing to consider is whether or not you want continuing advise from you advisor. If they get most or all of their money up front through the form of a commission, do they have an incentive to keep giving you some of their precious time, unless it’s to wrangle a client referral from you or to persuade you to change investment directions so that they can get more commissions? After all, when you’re doing whatever you do to make a living, do you spend a lot of time doing things that don’t bring you or your company any income or benefit?
Conversely, if the advisor receives no commission by putting you in something called a “no-load” fund (no purchase or exit fees), doesn’t he then have an incentive to continually stay in touch with you to help with your ongoing needs and questions, thus earning his 1 percent a year? Incentives typically influence human behavior, professional advisors included. Hence, you may want to think about how you’re paying your advisor so that you give him the incentives that work both ways to keep moving you forward. After all, isn’t that your objective, to keep moving forward?
Some Closing Thoughts. As a professional advisor, I don’t want to begrudge the mutual fund companies or other professional advisors of the income they’re receiving. They often provide valuable service. However, they do have the opportunity to be straight forward about how they’re charging you and how they get paid.
Also, a professional advisor, or a self-service mutual fund sales representative, should never overtly or implicitly insult or belittle a client for inquiring about fees. In fact, I take charge of initiating this conversation with every prospective client. I believe it’s part of my responsibility.
In summary, do you know every facet of your investment costs? Are you getting a good value for each part of your costs? Are the professionals you’re working with explicit and straight forward about the situation? And lastly, are you holding up your end of the deal by demanding this information?
I hope this helps with your investing and financial future. Ignorance can temporarily be bliss, but we all know it’s not a good long term strategy.
Rodney Schulz
President, Schulz Financial
President, www.GreatWealth.com
Copyright 2009, Schulz Financial, All rights reserved
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