In the pursuit of an investment adviser or investment manager one of the most important (and unfortunately complicated) pieces of information to obtain is their complete fee structure. As many see future investment returns more muted the level of total fees will become more important. After all, in a well-diversified balanced portfolio in the past century an 8% gross return was not unreasonable. Going forward a 5-6% gross return seems more likely. This being the case, a 2% total fee on an 8% gross return might be palatable (fee represents ~25% of gross return), but the 2% total fee on a 5% return is not (fee is 40% of return).
Before we get into the fee discussion it is also important to distinguish between the two types of investment advisers; as their fees, incentives, and duties to the client can differ significantly.
- Fee-only (independent) advisers make no compensation from fund or other investment companies with their only compensation coming via a flat fee charged to the client.
- Other advisers (brokers or wire-house advisers) can make money in many ways (management fees, compensation from fund/investment companies, commissions, etc.).
Here are all the investment adviser management fees you need to understand.
Adviser 'Investment Management' Fee (Flat-Fee)
This is the most straight-forward fee charged by most investment advisers. This is charged by all 'fee-only' advisers and some brokers. This type of investment management charge makes logical/ethical sense for the following reasons:
- Straight-forward and transparent; usually quoted as an annual flat percentage fee based on assets under management (AUM) and charged quarterly.
- Aligns the interest of the client and the adviser; if value of portfolio decreases adviser earns less in fees and vice versa
- Eliminates all potential conflicts of interests; adviser is paid no compensation by outside interests (commissions, funds, investment products, etc.)
- The larger the value of assets under management the less the yearly percentage fee will be; typical yearly percentage charges will run from 1.5% to 0.5%.
'Underlying Mutual Fund/Investment Product' Fee
This is the fee that the underlying mutual funds, ETFs, annuities, and products within a portfolio charge for their specific management. These fees are not easily found and the investor never sees these explicitly come out of their account; but make no mistake they are there and very meaningful! The fees are reflected in the prices of the investment securities themselves. For example, if you invest in both an 'actively managed' US stock mutual fund that charges a 1% yearly fee and a passive index US stock mutual fund that only charges 0.1%, assuming their investments performed the same the actual performance to the client will be very different. In this case if the stock market was up 10%, the active fund would show a 9.0% return, and the index fund would show a 9.9% return. This simple fact is why more and more advisers are moving towards a core of low cost passive investments. A typical portfolio 'underlying investment' fee would be between 0.2% (all index funds) and upwards of 1.5% in an 'active' portfolio.
These are the investment adviser fees charged by a broker to buy/sell stocks, bonds and some ETFs/ mutual funds. Normally, especially for larger clients, this can be one of the smaller components of the total portfolio fee. Typical commission charges will range from $7 to $15 per transaction. On a $1M portfolio assuming in a year there are ~ 30 fee transactions, total commissions could be in the $200-$450 range. In this example the percentage of the portfolio consumed by commission fees would only be 0.02%-0.04%. It is important to note however the smaller your portfolio the more important these fees become.
Mutual Fund 'Load' Fees
These are investment adviser fees which only certain types of advisers charge/receive. 'Loads' are charged by certain types of mutual funds and brokers and can be very meaningful. Loads can range anywhere from 1-5%. Some loads are charged up front (if you invest $10,000, only $9,500 would actually get into the investment) as $500 would be the immediate load charge. Other loads are back-end, where if you keep your investment in the fund for a period of 1-5 years the load is 'waived'. This arrangement does have a cost however, as it severely limits the liquidity of your money. Since these fees also open up the possibility for conflicts of interests with the investment adviser, in most cases it makes sense for clients to avoid advisers who utilize these funds.
All the above fees can reduce the 'real' total return of a portfolio for an investor. Being that investment fees are nearly 100% predictable, reducing costs is the easiest way to improve future investment performance. Generally if an investor avoids advisers who deal in 'load funds', are not compensated from commissions, and keeps higher cost 'active' mutual funds to a minimum are already ahead of the game. A quality independent adviser managing a $1M portfolio who utilizes mostly index funds/ETFs should have a management fee of 1% or less, an underlying investment expense of 0.4% or less, and minimal commission charges.
Therefore if your current investment expense is greater than 1.5% or so (in all) or you are holding 'load' funds, I would start questioning your investment adviser or look for a second opinion.
To learn more about Eric Mancini, view his Paladin Registry profile.
Previously posted on Paladin Registry.
About the Author: Eric D. Mancini is a Certified Financial Planner (CFP®) and the director of investment research at Traphagen. Eric graduated Penn State University with a BS in Economics and specializes in portfolio management, investment analysis, and personal financial planning. He also works with clients on insurance planning, tax planning, and personal income tax preparation. Eric has obtained the Certified Financial Planner (CFP®) designation, the NASD (National Association of Securities Dealers) Series 65 license, the NJ Life and Health Insurance license, and is currently pursuing his CFA® (Chartered Financial Analyst) designation.