In almost every conversation I have with a prospective client, at some point, the subject of investment fees comes up.
More often than not, an individual’s view of what they are paying in investment fees is far removed from reality.
The problem usually stems from the fact that many of the fees a typical investor pays are what I call “hidden” fees. In part one of this two part series on hidden investment fees, we’ll explore what some of these hidden fees are and whether or not an investor should be satisfied with paying them.
Before we go any further though, and before I get any “hate” mail from some of my fellow advisors, I need to clarify what I mean by “hidden.”
What are “hidden” fees?
What I mean by “hidden” is the fact that a large portion of financial advisors, brokerage firms, insurance companies, third-party administrators, and record-keepers do not offer a clear, transparent, convenient, and concise way for investors to determine whether or not they are paying these fees, and if they are, how much these fees are costing them.
I’ve had quite a few prospective clients in my office who didn’t think they were paying ANY initial or ongoing fees for their investments, annuities, and/or insurance policies.
This tells me that “someone” (usually the advisor) didn’t do a good job of explaining these products and their fees to clients.
Sure, an investor can certainly discover these fees by wading through the stacks of papers they sign when they open an investment account, buy an annuity or life insurance policy, or enter into a relationship with a financial advisor.
But how many people do you know read EVERYTHING they sign?
1. Account maintenance fees
These fees are typically paid quarterly or annually and are a fee you pay just for the “privilege” (insert sarcastic tone here) of having an account at a particular brokerage or investment firm.
The issue is that most account maintenance fees, like many of the other fees on this list, are not clearly listed in a place for the individual investor to easily see until after they’ve been deducted from the investor’s account.
In addition, sometimes an investor has to meet certain requirements to avoid account maintenance fees, but those requirements are usually buried in fine print.
With all that said, it is fairly common nowadays for a brokerage or investment firm to charge for paper delivery of statements and confirmations via USPS mail, but many firms will waive these fees if you opt for electronic delivery.
Transfer your account to another firm that doesn’t charge these fees OR opt for electronic delivery if it will eliminate these fees.
There’s no reason to pay for something when you can just as easily get it for free.
2. High expense ratios
An expense ratio is a fee that you pay when you own a mutual fund, ETF (exchange-traded fund), etc. It reflects the costs of operating the fund, therefore, it isn’t a “bad” fee in and of itself.
The problem is that the majority of individual investors own investments that have outrageously high expense ratios.
This is usually due to a fundamentally flawed investment philosophy by either the client’s financial advisor or the client themselves (check out this blog post for more information on how to determine whether or not your investment philosophy is fundamentally flawed).
Investing is one of the few things in life where you DON’T always get what you pay for.
In addition, this one truly is a hidden fee.
The reason it’s hidden is that you’ll rarely, if ever, see this fee listed anywhere on a monthly statement (except possibly on a 401(k) statement due to newer regulations that require more transparent fee disclosures for plan participants).
Although certain websites such as Morningstar.com will list a fund’s expense ratio, the surest way to find an accurate expense ratio for a particular fund is to scour the fund’s prospectus for the label “Total Fund Operating Expenses” or something similar.
If it’s more than 0.25 to 0.50% annually, then odds are pretty good you’re paying too much.
Talk to a fee-only financial advisor to develop an investment plan that will allow you to keep more of your fair share of market returns by picking funds that have low fees AND higher expected return potential for a given level of risk.
3. Sales loads or charges
According to investing education website, Investopedia, a sales load is…
A commission paid by an investor on his or her investment in a mutual fund.
In other words, if you invest $100,000 and the fund you’re investing in has a “front-end load” (i.e. sales load paid when initially investing the money) of say, five percent, then you’ll actually only be investing $95,000 for every $100,000 you hand over to the broker or advisor.
This isn’t the case with “no-load” funds (the only funds I recommend!). “No-load” funds are just that…funds that don’t charge loads (i.e. commissions) when purchased from the fund company.
Research has shown that, on average, investments with sales loads do not perform any better than no-load funds, and in many cases, they perform much worse.
In my opinion, a “loaded” fund is anything but loaded when it comes to an investment’s return potential.
Not sure if you’re paying sales loads on your investments?
Check out the fund’s prospectus or email me to set up a complimentary initial phone call and I can help you figure out the amount and type of any sales loads you might be currently paying on your investments.
4. Redemption fees
A redemption fee is a fee you pay for “redeeming” your money within a certain time frame of the initial purchase date. It may also be referred to as a contingent deferred sales charge or exit fee.
In some cases, this type of fee might be helpful because it can discourage folks from short-term trading and encourage long-term investing that, hypothetically, helps lower the overall operating costs of a mutual fund.
Again, the issue with this fee, like many others, is that most investors have no idea they will have to pay this fee because it’s usually buried in the fine print somewhere in the prospectus.
Stop day-trading and be a long-term investor OR find a fund that doesn’t charge a redemption fee.
5. 12b-1 fees
I know what you’re probably thinking…
Sometimes called a distribution and/or service fee, a 12b-1 fee is a fee included in the overall expense ratio of some funds and usually ranges from 0.25% to 0.75% of a fund’s assets.
A 12b-1 fee is just another form of a commission paid to compensate brokers and others who promote or sell the fund’s shares. It can also pay for advertising, printing costs, etc. and in most cases does NOTHING to improve the performance of the fund for the individual investor.
How do you know if your fund charges 12b-1 fees?
You guessed it…take a look at the prospectus!
In the table or section of the fund’s prospectus that lists the total annual operating costs of the fund (see #2 above), it should have a breakdown of the fund’s fees and you’ll be able to see whether or not a particular fund charges 12b-1 fees.
And in case you’re wondering, I DON’T recommend funds that charge 12b-1 fees.
12b-1 fees are just more “hidden” fees that increase costs to the investor without increasing the investor’s expected return.
But that’s not all…
Unfortunately, this list of hidden investment fees is only halfway complete.
Stay tuned for part two of our series on hidden investment fees.
In the meantime, if you’re having trouble determining whether or not you’re paying any of the hidden investment fees listed above, don’t hesitate to reach out to me via email and I’ll do my best to point you in the right direction.