By Matthew M. Glatt, CPA – Founder and CEO of FLP Financial Group, LLC
When you have money to invest, you are immediately faced with several choices about how you would like to allocate those funds. There are many factors to consider when selecting an investment plan. For example, if you plan to leave your money in an investment fund for several decades, your plan of action would be very different from someone who intends to invest for only one year. Likewise, a person looking to invest several hundred thousand will have a different plan from the investor looking to throw in $1,000.
Each person’s situation is unique and deserves individualized attention. For this reason, many investors choose to work with financial advisors to help guide them through the sometimes complicated process of investing and seeing returns. Of course, adding another person into the mix does mean that the potential for hidden fees goes up dramatically. This is why transparency is so important. No matter who you choose to work with, you should know the true cost of investing.
What I have done here is broken down five common types of investment funds. I explain what they are, and where the hidden fees lie below and provide an infographic at the end that you can save and keep on hand. As with everything in life, cheaper doesn’t always mean better. Some high-fee funds might be well worth your while, but again, that depends on your unique situation.
Here’s what your financial advisor should be telling you about fees:
Mutual funds are a type of investment which gathers up money from several different investors, and creates a diversified portfolio on behalf of all those investors. Mutual funds are very attractive because they are relatively uncomplicated, and they are a quick and easy way for investors to benefit from diversified investments, even if they themselves made a smaller contribution.
In other words, a person looking to invest $2000 may have trouble spreading that money out among stocks, bonds, real estate, etc. However, when we take that $2000 and put it into a fund where 50 other investors have also contributed $2000, we now have $100,000 to invest, and have a much easier time diversifying.
The fees paid on mutual funds tend to break down into two categories: costs associated with trading investments within the fund, and management costs.
Mutual Fund Fees: 1.44% average annual trading costs, plus 2.81% average management costs.
Exchange Traded Funds (ETFs)
Exchange traded funds are a type of investment that are designed to behave like stocks, and track the index of a specific market. This means that their value and price can change throughout the day much like stocks would. This also means that ETFs can be bought and sold throughout the day, just like stocks are.
Since ETFs are meant to go along with the flow of the market, they don’t require as much active management. This “passive management” often spells out lower fees for the investors.
Exchange Traded Funds Fees: 1.5% average expense ratio of specialty ETFs
An annuity is a type of investment that acts a bit like an insurance plan. Investors with a lump sum of money can place it in an annuity at once. The money can remain in this product gaining interest until you retire. At that point, you can begin receiving a fixed annual income which will pay out of the annuity.
These funds are attractive to people who are trying to play catch-up with their retirement savings, because they can guarantee a yearly income, and can provide peace of mind in that regard when planning for the future.
However, as you will see below, annuities can come along with very high fees (some of them not well defined) which investors should be aware of before making any decision.
Annuity Fees: 1.25% annual mortality and expense risk charge, plus administrative fees, plus underlying sub-account portfolio expenses, plus fees for special features, plus penalties of up to10% tax.
Real Estate Investment Trusts (REITs)
You already know that owning real estate is a good investment, but owning several properties comes along with its own set of hassles and inconveniences. To help investors sidestep the headaches of owning multiple properties, some financial advisors may recommend real estate investment trusts.
When you invest in REITs, you are investing in a company which makes money off of the real estate market. Some companies make money by owning real estate, while others make money off of the mortgage industry.
There is a range of fees for this type of investment, so be sure that your financial advisor spells it out clearly before you decide.
REIT Fees: average expense ratio range between .5% and 3%. 1.03% median real estate fund. 7% fees for non-traded REITs.
Hedge funds act in much the same way that mutual funds do, but with a few very important differences. For one thing, whereas mutual funds rely on individual investors to contribute all of the money, hedge funds may also include borrowed funds.
Furthermore, hedge funds are able to invest in a wider group of assets, which means more diversification, but that is largely because hedge funds are not overseen or regulated by the US Securities and Exchange Commission. Less oversight can mean more risk, so be absolutely sure that your financial advisor is leveling with you about what to expect in a hedge fund.
Hedge Fund Fees: 2.0% asset management fee, plus 20% commission on income.
No matter how you choose to allocate your money, the most important aspect of any investing relationship is transparency with your financial advisor. There are expenses associated with any business, and you deserve to know how much you are paying, and what you are paying for. Many investors do not realize that they are paying any fees at all, and those who do know about the fees involved are often underestimating them.
You are well within your rights to ask for a plain English, no nonsense statement of all fees, commissions, and penalties paid on your investments.
For a closer look at some highly detailed information on how investment costs breakdown, download the free white paper “The True Cost of Investing.”