I have worked in the professional investment advice business from Boston to Concord for more than 30 years and a lot has changed.
What has not changed, unfortunately, is fee transparency.
Despite significant legislative changes designed to increase investor knowledge, some investment advisors and managers have found ways to hide their compensation. Armed with the right information and if you know where to look, you can find it.
To start, there are several providers of professional investment advice, including: Brokers, Insurance Agents, Banks and Registered Investment Advisors. Each provider has a different level of responsibility and service and for this example we will use the simplest, most straightforward definition.
A full service advisor is responsible for executing your financial plan, overseeing your progress, and managing the three classic tenets of financial need – risk tolerance, time horizon and liquidity needs.
In addition, an independent investment advisor can help you by creating investment portfolios in a few different ways. They can purchase mutual funds on your behalf; they can create a portfolio with individual stocks and bonds, or create a portfolio that includes mix of the two.
Each of the professionals has a wide array of investment choices to choose from in order to develop a plan to meet your needs—and each one carries its own costs—which I’ll outline for you below.
Let’s start by taking a look at a few of the different types of advisory accounts available and the fees associated with them that you should (but might not be) aware of.
#1. Wrap Account Costs
According to Investopedia, a Wrap Account is used by a brokerage firm to manage an investor’s portfolio for an annual fee, which is based on total assets under management (AUM). This fee covers all of the administrative, commission and management expenses for the account. For many investors, a wrap account is less expensive than a brokerage account that charges commissions for trading. This sounds like an independent advisor who charges a fee for the management of assets. However, there is another level of fee that can be associated with wrap accounts.
Wrap accounts provide you, the investor, access to outside advisors who typically have higher minimums to entry. This means you must pay another level of fee to the outside advisor. According to CNBC, it’s not uncommon to “come across investors who are paying exorbitant fees in their portfolios. And even worse, they’re often paying 2 percent to 3 percent more.” I see it as one of the more expensive options for wealth management because you’re paying BOTH the manager AND your broker. Additionally, as an investor, you can be surprised at year end by higher than expected capital gains taxes.
Wrap accounts can also be invested in mutual funds. These types of accounts can be even more expensive, because—in addition to the two levels of fees describe previously—investors may be responsible for 12-B-1 fees. 12-B-1 fees are administrative and distribution fees associated with mutual funds. A broker can be paid a portion of this fee as well as the asset management fee.
Tip: You should always ask your broker or advisor if they are collecting a 12-B-1 fee in addition to their asset management fee.
#2. Costs Associated With Investing Through Your Insurance Broker
While I feel that life insurance is an important part of a comprehensive financial plan, I do not believe insurance should be used for investment purposes. Life insurance is a great way to provide for dependents which won’t have the means or income to support themselves after you pass away. Term insurance is less costly and has the same tax benefits as other permanent insurance. Whole life, variable life and annuity contracts can have investment components to them in addition to the death benefit. However, the heavy fees associated with cash-value plans can erode your investment returns significantly. For example, life insurance can have an upfront cost to establish your contract, investment management and expense fees during the life of the product, and—finally—mortality charges.
TIP: An alternative to a cash-value plan is to deposit the difference between the premium cost of term insurance and other insurance options into an investment portfolio or mutual fund account.
#3. Exchange Traded Fund Fees
An Exchange Traded Fund (ETF) is a fund that trades on the market like stock. ETFs are a lower-cost option than traditional mutual funds. Typically, they have lower management fees because the companies that provide them are tracking certain indices or sectors—keeping costs manageable—and transparent. Since ETF’s are traded like stocks, they can be bought or sold inter-day. Inter-day executions can provide greater liquidity and enhanced tax-efficiency.
TIP: A broker may charge a commission for the purchase of an ETF similar to one charged for purchasing a stock.
Two Questions You Should Ask
When considering investment options, it is a good idea to ask your advisor these two questions:
- What fees will not be listed on my invoice or statement? A good advisor will always answer this question in detail and show you where to find these charges on your statement.
- What are my trading costs? Independent Investment Advisors need to purchase shares of mutual funds, stocks and bonds through brokers. The trading costs eat into the performance of the portfolio, so your investment advisor should be working really hard to keep those costs as low as possible. In most cases, your trading costs will be highest when the manager is implementing your new investment strategy.
Past performance is no guarantee of future results. Returns are presented net of management fees. There can be no assurance that any of the securities referred to herein were produced for or remain in portfolios managed by Granite Investment Advisors. A complete list of all Granite Investment Advisors’ recommendations within the preceding year is available upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities described herein.