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How Much Are You Paying for Advice?

Originally published
Originally published: 10/28/2016

Your customer’s furnace or air conditioner stops running and they call you. What’s the first thing they ask? For most people, it’s “how much?”

Yet when it comes to investments, most people seem content to just “let it be” and not think about it. The problem with this approach is that the fees you pay for investment advice can add up to a pretty large number as the years go by.

Why is this information so hard to come by?

If you’re having your investments managed by a broker at one of the major “wirehouses” (such as Merrill Lynch or Morgan Stanley), the key word is opaqueness. The fee structure is difficult to completely know (a cynic might say that they really don’t want you to know).

For example, if you go to the website of one of the major wirehouse’s (let’s call them “XYZ Inc.”), to the section entitled “understanding our commissions and fees,” you’ll find two and a half pages of explanations.

Some excerpts:

How XYZ is Compensated by You

Depending on the type of relationships you establish and the way you choose to do business with us, XYZ may be compensated for the services we provide through transaction commissions and markups, asset based fees and other fees and charges.

The problem with this, is that it’s so open-ended that fees could be charged for just about anything.

Other Compensation

XYZ and its affiliates may earn compensation in other, more indirect ways with regard to the certain products you purchase or services you receive.

Once again, how can you possibly know what you’re paying under such an unclear structure?

Fee Structure

One of the biggest trends in wealth management over the last 10 years has been the loss of market share at the major wirehouses and the attendant growth in the independent Registered Investment Advisory (“RIA”) space.

One of the key reasons for the growth in the RIA space is the transparency of the fee structure. Typically, the client pays a management fee at an RIA firm.

This fee is the only way the Advisor is compensated. There is no additional compensation paid to the broker or the firm. The Advisor is not “incentivized” to do anything other than what they feel is in the best interests of the client.

This is in contrast to the complex and unclear way the wirehouse broker is compensated.

Another example of the problem with this lack of transparency is how brokerage firms may be compensated for selling another firm’s products.

In an article entitled “Fund Payments to Brokerages Draw SEC Scrutiny” by Jed Horowitz of Reuters begins:

The tens of millions of dollars in annual fees that mutual fund companies pay to brokerages and their financial advisors to encourage sales of certain funds to retail investors are growing in size and variety, but the phenomenon is largely invisible to investors.

The U.S. Securities and Exchange Commission, which 18 months ago began a review of fees paid among mutual funds advisors, fund companies and the brokerage firms that sell the funds, has uncovered a complex geometry of payments that may lead to sales of certain funds at the expense of others and is not clearly disclosed under regulators’ current requirements, according to a person familiar with the review.

Once again, the lack of disclosure for these fees makes it impossible for the typical retail investor to know what they are paying.

Finally, another area where people are probably paying a lot more than they think is through the use of mutual funds.

The cost of transactions (the buying and selling of securities) by the mutual fund is NOT included in the fund’s standard expense ratio. In selecting mutual funds, most investors know to check the expense ratio, the standard measure of how costly a fund is to own.

There are other costs, not reported in the expense ratio, related to the buying and selling of securities in the portfolio, and those expenses can make a fund two or three times as costly as advertised”

Once again, the issue of transparency rears its head. Paying 2-3 percent in total annual costs may work for the Mutual Fund company and the advisor selling the funds, it may not be a very good deal for you.

What’s the Answer?

If an investor wants advice, they’re probably going to be better served by working with an “independent” advisor (typically working at an RIA firm because of the clarity and transparency of the fees being paid).

For many investors, actively managed mutual funds (and other “structured” products) may not be the best option. Instead, invest in individual equities or else very low cost (10-20 basis point fee) exchange traded funds.

Just like your customers want to know what it’s going to cost them for the service you perform, you should know what it’s going to cost you when you work with a wealth advisor to manage your investments.

 


Frank Pedace is a Senior Portfolio Manager at Laurel Wealth Advisors in La Jolla, Calif. He is a Chartered Financial Analyst Chartholder, and also holds the CFP and CLU designations. He can be reached at f.pedace@laurelwa.com or 858-459-1101 x515.

 

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