Not long ago I was meeting with a couple who were relatively new clients. We were going over data on a recent mutual fund investment, and I commented that I was surprised to see the fund offered a commission of 2.25%. As a fee-only financial planner, I rarely pay much attention to whether a fund pays a commission to a broker. I purchase mutual funds on behalf of my clients through a discount broker where no commissions are included in the price.
The clients asked for an explanation of my comment. I told them that commissions were common and that 2.25% was actually on the low side. It’s not unusual for equity mutual funds to charge 5.75% of what you invest. On the other hand, fee-only financial planners typically charge fees of about 1% annually.
They were surprised to learn that, had they dealt with a stock broker or mutual fund salesperson, the purchases we had made over the past few months would have cost them around $28,000 in commissions. Instead, they had paid me about $9,000 in fees for full financial planning, not just investing their money. At this point, the wife turned to her husband and said, “I guess now you will stop complaining about his high fees!”
The notion that a fee-only planner has high fees isn’t unusual. The main reason for this misperception can be explained in one word: disclosure.
Most customers of financial product salespeople don’t pay attention to how much they pay in commissions. That amount is easy to miss unless you read the fine print or ask the right questions. You will never receive an invoice for the commission or have it appear on any statement because the fund company takes commissions out of either the principal you invest or your return.
If the commission is taken out of your principal (called a front-end load) you will simply receive fewer shares than the total amount you invested could have purchased. It’s like paying $100 to Safeway and only receiving $95 worth of groceries because $5 went to the cashier.
A commission taken out of your return (called a back-end load) is even harder to spot. For example, if your brokerage statement shows a fund had a return of 5% in any given year, that return is always stated after deducting expenses and commissions. In this example, the fund really earned 7.5% and paid 2.5% in expenses and commissions—not an uncommon amount. You then netted the remaining 5%. To find out what the fund paid out in commissions, you would have to dig deep into the prospectus.
This lack of full disclosure is one reason why so many customers of financial salespeople think they don’t pay their advisor anything. They never get an invoice or see a statement where the commission is deducted. The only way to know exactly what fees they pay is to ask and insist on getting a clear answer.
Contrast that method of payment with that of a fee-only advisor. All of a fee-only professional’s clients know exactly what they pay annually. Most of the time, they must write a check two to four times a year. Even when clients prefer to have the planner’s fees deducted from investment returns, they receive invoices clearly stating the amount of the fees.
This disclosure ensures that clients know what they’re paying. That total amount can seem high, even though it is less than a broker’s commissions would be. Commission salespeople count on the fact that, to the unknowing customer, a fee you don’t see is always easier to stomach than a fee you see.
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