The average investor has neither the time nor the expertise to devote to micromanaging a complicated and diversified portfolio. For this reason, investors often hire financial advisors to help them with that aspect of investing. Of course, investors understand that these financial managers must be paid in some way but very few understand exactly how that shakes out, and what it means for them. This can sometimes spell trouble.
Before you begin your new investment, you are likely handed a breakdown of costs that you can anticipate either quarterly or annually. These might include broker commissions, maintenance fees or even an upfront deduction from your initial investment money – but in many cases, that is only the beginning of the story.
When investors sit down and go through their investment statements with a fine-tooth comb (usually with the assistance of a new financial manager) they are shocked to discover that there are hidden costs to investments, some of which are alarmingly high. They’ve been losing money to fees that they never knew about, and it’s been happening for years.
So what is the story with these, and how can you as an investor keep an eye on what’s happening? Let’s answer that through a few different strategies.
Understand What Is Meant by Hidden Fees
Financial advisors are required to disclose certain fees, but not others. For instance, the paperwork on the average mutual fund probably spells out the fact that there are annual fees for account management and advertising (sometimes listed as 12b-1 fees). As an investor, since you see these listed out, you may assume that they are the only fees you will be paying in this mutual fund.
However, did you know that each time money is moved around and reinvested (or rebalanced), you get charged transaction fees for that? Did you also know that those fees do not have to be spelled out before you agree to invest in a mutual fund?
Certainly one could make the argument that it is impossible to predict how frequently mutual funds will need to be rebalanced, and therefore a financial advisor couldn’t realistically inform investors on how much it will ultimately cost them – but that also means that there is financial incentive for your fund manager to move your money around, even if it is not in your best interest.
Another thing to watch out for is commission. Your broker may say to you that they are earning .37% commission on your portfolio per quarter. This sounds like a great deal, because it is such a small percentage. However, .37% per quarter is simply another way of saying (approximately) 1.5% per year, and that is a significantly higher commission.
If you are getting the impression that many of these fees seem purposefully confusing, you’re right about that. Which brings us to our next point…
Ask For Full Transparency With Your Advisor
The absolute first question you should ask any financial advisor or mutual fund manager that you wish to work with is “Are you a fiduciary?”
A fiduciary is a financial advisor who is legally bound to work only in a client’s best interest. They charge a flat fee rather than commissions to further ensure that there is no financial benefit to them investing your money unwisely.
Believe it or not, financial advisers are not required to be fiduciaries, and therefore are only required to make “good” investments on your behalf, and not the best possible investments. If the financial advisor you are currently working with gives you anything other than an unequivocal “yes” when you ask them if they are a fiduciary, chances are they are not, and that means they have financial incentive to charge you more than is necessary. It may be time for a change.
If you are working with a fiduciary, you can ask them for a complete breakdown of all costs associated with your investments. Specific fees to ask about include brokerage fees, back-end load fees, redemption fees, management fees, transfer fees, inactivity fees, the cost of limit orders, and overhead costs such as accounting or bookkeeping.
There is a lot that goes into managing an investment portfolio, and that work is worth paying for if you are seeing the best possible return that you can on that investment. A poorly managed investment may return several percentage points lower than a well-managed investment. Over the course of years or decades, mismanagement can mean the difference between retiring comfortably, or struggling to meet expenses. Every single percentage point matters.
Learn How to Determine the True Cost of Investing
The most important aspect of any financial fee is to determine whether or not they serve you as an investor. In other words, do your financial advisers goals align with your own, and are the fees being charged the result of them working in your best interest?
An overly complicated portfolio in which investments are moved around, traded, and sold too frequently is much more likely to benefit the person managing your account than it is to benefit you. This is why it is so important that you have an open, transparent, and trusting relationship with the person managing your investments.
You want to work with someone who does not hesitate to spell out all of the costs and fees associated with your investment, and to continually provide you with easy to follow updates. If you do not feel you are currently getting this kind of service, you may be losing money unnecessarily, and that money might be going into the pocket of the person who was supposed to be working for you.
There is a lot to unpack in the average investment portfolio, but a trustworthy financial advisor will be able to do it for their clients without a problem. For more information on how much investing may be costing you, download this free white paper: “The True Cost of Investing.” This document spells out some specific questions you should be asking, as well as hidden fees you should be looking for in your accounts.
