The subject of fees is one that I dreaded when I first started working in this industry. I loved talking about the underlying investments we recommend for our portfolios, and I loved talking about the way markets are efficient and work for the end user, namely the client. But when the subject turned to fees, I got uneasy. People are entrusting you with their savings, and are very curious as to how much of their money would be going to the advisor. I work for a strictly fee-only advisor, so our fees are as transparent as possible. We tell our clients what they will be paying upfront, and then send them a quarterly billing statement showing the fee that will be deducted from their account.
With full disclosure in hand, I started to wonder how our competition, namely brokerage houses, went about gathering their fees. And then I started hearing statements like, “my friend doesn’t pay any fees for his investments” or “I don’t think my current broker is taking anything out for fees.” That’s when I first realized that not all investment professionals are held to the same standard. I started looking into the different fees clients of brokers are charged, from front-end and back-end sales charges and commissions, to mutual fund expenses that are handed over to the broker, and additional financial planning fees charged. My feelings about discussing fees switched in an instant when I realized the fees my company charged were actually something to be proud of, because they are spelled out in black and white. And when taking into account the average fees brokerage clients paid to all different sources, I found that our fees are very competitive (even quite a bit less in many cases). Now fees are one of the first things I talk about when I meet with a client, as that is a major selling point for using a passive strategy and letting the markets work for you.
Study after study has shown that active management does not, on average, add anything to the investor’s return, and, in fact, generally underperforms the market as a whole. The fees involved in this practice, namely the commissions and transaction costs paid to constantly buy and sell stocks or mutual funds, eat away at the bottom-line investor return. For the average client of a brokerage company, the up-front sales charges become a major hindrance to investor return. These charges can range from 3%-6% of the amount invested right off of the top, going to your broker. On top of this, I am seeing more and more of these brokerage companies charge additional “financial planning” fees on top of the commissions they are receiving. It seems as if these companies are taking advantage of the popularity of fee-based services, but not willing to give up the commission-based products they have learned to know and love. And in the end, it’s the average investor that is stuck footing the bill.
The average investor’s mindset perpetuates the practice of commission-based active management, through the thinking of “if my broker is constantly buying and selling, they must be doing something to increase my returns.” The practice of buying and selling may actually just be increasing your broker’s bottom line, and suppressing the returns you should be receiving from your investments. Building an asset allocation that is appropriate for your age and stage in life, and sticking to that plan using low-cost index-type funds is your best bet for long-term success when it comes to your investments. So the next time your broker calls you and says “I have a new investment I want to put you in, we’ll just need to sell something else” or “you have a gain in a certain fund, let’s sell it and buy something new”, think twice about the move, and ask what fees and expenses you will be paying to make that change. By finding out how much your broker will profit from the move, you might be able to decipher whether the move was truly recommended with your best interest in mind.
- Andy Fitzpatrick, CPA