by Eve Kaplan, CFP(R)
Don’t get trapped by The Great American Investment Rip Off! I’m not talking about dubious investments or Ponzi schemes – I’m talking about various layers of fees that seemingly respectable advisors may be charging you without you being aware of it!
A case in point is “Jill,” who I met several years ago. Jill came into my office with paperwork for her $2,000,0000 portfolio. She told me she rarely had contact with her advisor, who charged her a 1% annual investment management fee ($2,000,000 x 1% per year = $20,000 annual fees). Jill was horrified, however, when I explained to her that she was – in effect – paying her advisor $70,000 a year for her investments – not just the $20,000 on her invoice.
How easy is it to pay – unknowingly — an extra $50,000 in fees on a $2 million account? Very easy. Unlike purchase of a home, car or other item with a clear price tag, investments that generate additional commissions to advisors come in all shapes and sizes. The advisor is supposed to disclose all the types offees he or she charges a client, but my clients tell me they weren’t aware of these additional fees.
Here’s how Jill was paying an extra $50,000 per year:
1. All of Jill’s investment mutual funds were “C” shares. I asked Jill if she was aware of this and she told me she wasn’t (like most client who come to me, she didn’t know what A, B or C shares were – and didn’t recall the advisor explaining these to her). Each of the C shares Jill was sold give her advisors an additional annual recurring 1% commission. $2,000,000 x 1% C Shares fees = another $20,000 in annual fees paid to the advisor – instead of retained by Jill.
2. Jill’s former advisor invested her account in relatively expensive mutual funds that cost Jill – on average – 1.3% per year (note: these fees are payable to various mutual fund companies). If Jill had been invested in more cost-effective funds that charge e.g. 0.3% per year, she could have saved 1% per year in extra fees. Using the $2,000,000 example, Jill was spending an additional $20,000 per year to pay for relatively expensive mutual funds — with no indication they do better than less expensive ones.
3. Jill has $1,000,000 in a taxable (non-IRA) investment account and $1,000,000 in a Rollover IRA. These were invested willy-nilly by the advisor, with no attention paid to relative tax efficiencies of the two account types. Jill’s $1,000,000 non-IRA account contained ordinary bond mutual funds (not municipal bond funds), real estate mutual funds and a wide range of equity mutual funds with extremely high turnover ratios. As a result, she was earning a lower rate of return by having the wrong types of bonds in her taxable account, and she was paying significant short- and long-term annual capital gains taxes each year by holding positions that were not designed to minimize taxes. A rough back-of-envelope calculation of the additional cost to Jill is $2,000,0000 x 0.5% = $10,000 or more per year.
If you add the additional cost to Jill of C shares, expensive underlying mutual fund fees and tax inefficient asset allocation, the damage can be quantified as an extra $50,000 a year Jill wasn’t aware she was paying. Advisors who charge additional commissions and other fees are supposed to clearly disclose this to clients but I’ve NEVER met clients who remember being told what the various types of fees are (and how much it might cost the client). This reflects poorly on the investment industry – not on busy individuals who otherwise make intelligent decisions and who engage advisors in good faith to manage their investments.
The term “Fiduciary” has been thrown around a lot and the public is confused about the meaning. In the context of investment advisory fees and products, it boils down to this: Is your advisor sworn to put your client interests before his/her own? (one way to do this is to avoid mixing product sales with advice-giving). Or are you working with an investment advisor who isn’t required to put your needs first – and can sell you products that he/she feels are “suitable” for you? “Suitable” is a very slippery term that’s open to interpretation and has little backbone.
Further, Jill didn’t realize she was working with a “fee-based” advisor – she thought her former advisor didn’t sell products or earn commissions. That’s because Jill received a quarterly invoice for 1% of her $2,000,000 investment assets. It’s also because Jill thought “fee-based” (selling some products) is the same as “fee only.” A fee-only advisor only will charge by the hour, retainer or as a percentage of assets that are under management. A good fee-only advisor will advise on all aspects of a client’s financial life and not just “manage investments for a high fee.” Ideally, the fee-only advisor is a Certified Financial Planner® or has another planning credential that demonstrates some minimum level of financial planning competency.
A great resource to clear up ambiguity about advisory fees can be found in a free booklet by NAPFA (the largest fee-only organization in the US). Go to How to Find an Advisor for more information. Some fees are legitimate and reasonable for services rendered — and some are just a complete rip-off!
(C) Copyright 2015 by Eve Kaplan. All Rights Reserved.