When it comes to investing, the hope is that your nest egg will grow into something bigger — regardless of whether it’s earmarked for your children’s education, retirement, or some other long-term goal.
But growth — specifically in the financial space — is tricky because there is no magic bullet.
A number of factors determine whether you gain or lose money on investments and one of the most important is fees.
Investment-related fees and expenses are particularly troublesome to investors because they directly reduce your portfolio’s return. For example, if your portfolio gained 8% for the year but you paid 2.5% in fees and expenses, your return is actually only 5.5%.
Over time, that difference can really add up.
Often, we hear how expensive investment fees are. But what does that really mean? What constitutes “expensive” in the world of finance?
There are tons of different types of fees, some paid by the consumer, some by the advisor — so much so that it’s hard to know what’s what.
To help make some sense of it all, here’s an overview of the types of fees you may hear about.
Planning Fees
Planning fees are the payments for doing business with a financial advisor. Depending on the type of financial advisor you work with, the amount and ways these fees are charged may vary. These fees are often separate and distinct from Asset Management and other fees.
Let’s take a look at some of the common types of planning fees that you could be charged depending on the financial advisor that you select.
Commissions: This is one of the most common ways that a financial advisor charges for their services.
When an advisor is paid a commission, he or she is being paid by the companies whose products they are selling you. This is neither a good or bad practice, but it may color the advice you receive. It could also save you a lot of money if you just want to make a purchase and are not looking for additional advice.
Flat Fee: Paying a flat fee for services can be beneficial when you need a one-time financial plan. You could benefit from an expert crunching the numbers and helping you navigate all the moving parts that go into an accurate plan projection that encompasses your entire financial situation.
Since a flat fee is not tied to the value of investments or generated by the purchase of any specific investment, the advice you receive should be objective.
Retainer Fee:
If you have a more complex financial situation, or are looking for continued advice that may require ongoing work, a retainer fee arrangement could be a viable option.
Advisors that charge a retainer fee will generally offer a complimentary introduction meeting to learn more about you and your finances. After learning about the complexity of your situation, they can tell you what your retainer fee would be, how often it would be charged and what services are included in that fee.
Asset Management Fees:
Asset management fees are the costs related to having your assets professionally managed. This fee compensates the money managers hired to select securities, rebalance asset allocations, and continually monitor your portfolio.
While management fee structures vary, they are typically based on a percentage of assets under management, although flat-fees are gaining momentum.
Mutual Fund Expenses and Fees:
Front-end Load: This refers to money that you pay upfront when you invest in a mutual fund. This is a form of commission paid to your broker or financial advisor when you buy a fund with a front-end sales charge.
For example, let’s say you buy a fund with a 5% front-end sales charge. If you invested $1,000, you would only get $950 worth of funds, with the rest going toward fees.
Back-end Load: Refers to money you pay when you sell your shares of a mutual fund. This expense can range from a flat fee to gradually decreasing over time as a way to incent investors to hold their investments long-term.
Similar to their front-end counterparts, the commissions on these funds are paid to third-parties and are not considered a part of the fund’s operating expenses.
Expense Ratio: An expense ratio is the fund’s annual operating expenses, expressed as a percentage of assets. Someone has to pay employees and the light bill.
Unlike the previously mentioned sales charges, this cost applies to all mutual funds. While the fee can range from 0.05 – 2%+, the average is around .05 – 1%.
12b-1 Fees: 12b-1 fees pay for the fund’s advertising and sales expenses and is generally between 0.25 and 1% of a fund’s net assets. These fees are named after the section of the law that allows them in the Investment Company Act of 1940.
Trailing commissions: These are the commissions that a mutual fund pays each year to the company that sold you the fund — for as long as you hold the fund. The rate of the trailing commission is determined by the company that created the fund. You are more likely to see these with insurance contracts.
401k Participant Fees:
Ever heard the saying “there’s no free lunch”? Well, it’s true and 401k plans are no exception!
Whether it’s you, your employer, or a combination of the two, someone has to cover the costs related to involved in setting up, managing and reporting for your retirement plan. Not to mention compliance requirements.
According to a TD Ameritrade survey of 1,000 investors, around 96% knew how much they paid each month for streaming services like Netflix, Hulu, and Spotify, yet only 27% knew how much they were paying in fees on their 401k accounts.
What’s worse, 37% believed that they didn’t pay any fees related to their 401k account.
The reason is simple.
These fees are automatically taken out of an account that few people look at on a regular basis which makes it easy to overlook exactly how much (or even if) you’re being charged.
If you’re not sure of your fees, ask your employer for the latest annual fee notice for the plan as each plan is different. The Department of Labor requires that you receive this information.
The Bottom Line
Certainly, fees are one of the primary determinants of investment returns and over time and minimizing fees could mean maximizing performance. When evaluating fees, ask yourself these questions:
- Is this a planning fee? Or an asset management fee? Planning fees compensate an advisor for their time, effort and deliverables to you. Asset management fees compensate an advisor not only for their time but also for ongoing professional money management that is outside the scope of most individual investors.
- Is this a fee that I can change? Expenses ratios and Commissions are baked into the product. Some other fees may be negotiated, or you may benefit from breakpoints.
- Do I have other investment options? If you own a fund that charges 1.5% and another similar fund that charges .75%, you may consider changing. It’s worth a look, at least. You will have more flexibility to do this within an IRA, Roth IRA, or regular investment account as opposed to your 401(k) or other retirement plan. The investment choices you have are set by the employer, but you may still find some pricing efficiencies.
- Does this service provide me value? If a mutual fund is inexpensive yet continually loses value, doesn’t perform well compared to similar funds, or isn’t meeting your current goals, it may be time to change. Maybe your advisor gives you free advice, and we all know what “free” is worth. If your advisor isn’t giving you the answers you are looking for, start shopping around.
Your key takeaway here: The fee is not as important as the value you receive from the service.
If you have questions about fees or would just like a second opinion feel free to reach out at pam@pathfinderplanningllc.com or click here to schedule a free consultation.
Pathfinder Planning LLC provides personal financial planning advice and asset management for a simple fee to young adults and working families in North and South Carolina through group classes, one-on-one planning, and ongoing advice.
Your Financial Mom blog posts are not meant to be legal, accounting or other professional service advice. Content represents the opinion of the author only. Pathfinder Planning LLC is not responsible for the accuracy or validity of content contained in third-party comments.