1. An up-front commission earned by the salesperson or their firm. Don’t rely on a vague assurance or a verbal answer: get a specific number in writing.
If you have trouble getting a number, ask, “If I buy this investment today and want to get out tomorrow, how much do I get back?” If the answer is not “all your money,” the difference is probably the upfront fees and commissions.
I don’t recommend purchasing financial products with significant upfront commission or costs. I have seen investments where these fees run as high as 30% of the money invested. If you were to earn 5% a year on the investment, it would take 8 years just to break even.
2. Ongoing advisory fees. These are monthly, quarterly, or annual fees you pay advisors for their investment advice and oversight. This includes working with you to pick the asset classes, set the diversification, select the managers, tax optimization, rebalancing, and other periodic tasks.
This fee can have many names including wrap fee or investment advisory fee. The normal “rule of thumb” is 1% of the assets the advisor is managing, although fees can range from 0 to 7%. This fee can be charged to you even if the advisor receives an upfront commission. It can be easy to see or hidden away in the fine print of the investment.
3. Additional fees for services. Find out specifically what services are included in the advisor fee. Additional fees for financial planning or ancillary services are rarely disclosed or discussed.
Services can range from minimal hand-holding only focused on your investments to comprehensive, holistic financial planning. Amazingly, there is no correlation between price and the breadth of services. That’s illogical, but the financial services industry gets away with this, in part because consumers don’t do their homework.
4. Ongoing fees charged by the managers of the specific funds or investment products. These fees are referred to as the fund’s expense ratio. This comes out of the profits generated by the manager, and it is one of the hardest fees to find. Only the most transparent advisor or salesperson will disclose it. It is incredibly well hidden; you will never see it in your brokerage statements or your advisor’s invoices. The only way to know the amount of this fee is to read the prospectus or some other third party analysis of the investment, like Morningstar.
These fees can vary greatly for the same investment, depending on the class of share you buy. For example, American Fund’s New Perspective Fund’s expense ratio ranges from 0.45% to 1.54%. The average expense ratio of a mutual fund that invests in stocks is 1.35%. Conversely, the average expense ratio of a Vanguard S&P 500 fund is 0.10%. The difference of 1.25% is staggering over time.
5. Miscellaneous fees. These are also rarely talked about and hard to find. Many advisors charge $50 to $100 a year per account, hundreds of dollars to open or close an account, and even fees to dollar cost average your funds into the market.
6. Transaction fees. Every time you buy or sell a fund, a fee is typically paid to a custodian. These can range from $5 to hundreds of dollars per transaction.
Remember, it’s your job to persist until you find out the total costs of an investment. Next week I’ll suggest ways to ask the tough questions about fees.