— Many ardent shoppers will spend hours investigating a car dealer’s profit margin or the markup on a big-screen TV — but think nothing of turning over their life savings to an investment adviser with only a cursory discussion of fees and other charges.
One reason is that the financial services industry has done everything it can to bury those fees in the fine print. To find out what your investments cost, you have to understand where to look and then do some digging. And the time to ask is before you open the account.
Bankers are being vilified these days for the blizzard of new fees they’ve invented for consumer loans and credit cards and the excuses invoked to apply them: late fees, overdraft fees and “just-because-we-can” fees. Investment advisers have escaped the wrath of individual investors largely because they’ve figured out how to keep most people in the dark about what they’re charging for their services.
Investment fees typically come in layers. Let’s start with the 1 percent “commission” your broker is charging you. That’s actually an “investment advisory fee," the money you pay for the advice you’ll get about how much you should invest in stocks or bonds, which ones to invest in, when to sell, etc.
The fee is based on the size of the account under management, so if you have $100,000 in savings you’ll pay 1 percent, or $1,000, every year. Fees are usually billed quarterly. But they're not always easy to find on your statement. Ask your adviser to show you where to find them.
So far, so good. Your adviser has to make a living, after all, and this is her primary source of income, or should be. It’s worth noting that while your interests are marginally aligned (the bigger you account grows, the more you’ll pay in fees), your adviser collects a fee whether or not her advice makes you richer.
Commissions are another source of income, one that can potentially put your interests and your adviser's at odds. In the old days, stock brokers earned commissions every time they bought or sold a stock on your behalf. Those commissions were substantial enough that a broker could make a good living from them. But over the past 25 years, deregulation and online trading have whittled those commissions down. Still, you should ask up front how much you’ll pay to buy or sell a stock in your account. If your adviser isn’t offering you discounted commissions, you may want to find another adviser.
Commissions are clearly spelled out when you trade shares of stock. But that is not true with some other types of investments such as mutual funds. This is where the fee picture gets murky; there’s a long list of potential charges and commissions. These may be “one-time” fees that are charged when you buy or sell shares in the fund (or both). Then there are ongoing expenses: a management fee for the fund advisers who decide where to invest your money or an “administrative” fee to pay the light bills at the office. Don't forget to ask about the mysterious “12b-1 fee” that lets a mutual fund company charge for the cost of stuffing your mailbox with sales brochures urging you to buy more of their funds. (Here’s a rundown of typical fund fees to ask about.)
A major problem you’ll have tracking these fees is that they won’t necessarily show up on any statement you get; some are taken directly from the money everyone has invested in the fund. But it’s still your money.
Mutual funds that charge “front end” sales commissions do even more damage to your portfolio. These fees are paid directly to the broker who sells you the shares in that fund. That means you may be getting steered to a fund because it’s a good deal for the broker, not for you. The only way you’ll find out is to ask.
One way to avoid some of these conflicts is to ask for an account with a “wrap fee.” That means that your investment adviser will cap your costs at, say, 1 percent of your account. Any fee paid to other investment companies, such as the manager of a mutual fund, comes out of that 1 percent.
Another reason the financial services industry gets away with all these fees is that, when disclosed as a small percentage, it doesn’t sound so bad. But, in percentage terms, your gains are also likely to be in the single digits, on average, over the years. So if your account grows by 5 percent, and your advisor gets 1 percent, she’s pocketing 20 percent, of your gains.
Add on separate fees for mutual funds or investments like variable annuities (which can charge 3 percent or more) and the hit can be substantial. For example, if your $100,000 nest egg grows 5 percent a year, a package of fees that amount to “just” 2 percent will cost you $29,879 over 10 years.
So before you sign those forms to open an account, satisfy yourself that you know what this is going to cost you. Ask lots of questions. And get the answers in writing. A good broker or adviser won’t mind taking the time to walk you through them.