Lions And Tigers And Fees Oh My!
There are advisors today who make a big deal about the fees the “other guys” charge. Apparently, they want you to believe that they don’t get paid to help you – or at least not as much. Do you think that’s true? Discussions about fees can get confusing because there are a lot of different kinds of fees. Let’s talk about fees, and then I’ll give you a great question to ask when it comes to determining if the fee you pay is a good thing, or not.
First, let’s be very clear. No matter what investment vehicle you choose, the company that issued it and the advisor that sold it to you, are going to make money. That’s a good thing. If they can’t make money, then they can’t help you. The problem with fees is when advisors use the existence of fees to mislead you about the value of other financial vehicles you may be considering. The common question most advisors want you to ask is: How much are the fees? That’s not a very good question, because it provides no context for the answer. The better question is: What do I get for the fee?
A good follow-up question is: Do the fees come out of my pocket? Let’s apply those questions to common investment options.
1. Mutual Funds – In a brokerage account set up by your advisor, the average fee (front-end load) is usually around 4.5% to 5.5% of every dollar you invest. For the fee, you get access to your account information, and the service and advice provided by your advisor. The fees do come out of your investment, so about 95% of your money goes to work for you on day one. In addition, there are annual fund expenses, usually around 1%. This fee pays for the printing of materials for fund holders, advertising costs, and various administrative fees. These fees also come out of your investments. If you change from one fund to another, you pay the initial fees again.
2. Mutual Funds – In a managed account set up by your advisor, all the fees associated with the brokerage account are waived. In their place is a management fee, usually around 1% of the account value annually and billed quarterly. The idea here is, the advisor has a vested interest in making your account grow because the more you make – the more they make. Of course, if the account value goes down, the advisor still gets paid. For the fee, you get your advisor’s ongoing advice, and the ability to move from one fund to another without a new charge. The fee comes out of your investments (usually ¼ of 1%, four times a year – every single year).
3. 401(k) and 403(b) Plans – Fees can vary widely on these plans, but research shows that participants can pay up to 3% in fees on their company-sponsored retirement plans. For the fees, you get access to the plan representative and any information you need regarding the plan. The fees do come out of your investments every year.
4. Variable Annuities – These contracts usually have two or three different kinds of fees. First, the Mortality and Expense (M&E) charge. This fee is usually 1.25% to 1.5% annually. For this fee, since your principal is not guaranteed, you get a guarantee that even if market losses cause your account value to drop, your death benefit will still be equal to your original investment. Second, (optional) the Guaranteed Income fee. This fee is usually 1% to 1.2% annually. If you choose this option, you are guaranteed that even if market losses cause your account value to be lost entirely, you will still receive a guaranteed income every month (or quarter, or year), until you die. Third, the sub-account fees. Each investment option in a variable annuity has a fee, and they can range from less than a half percent to around 1% annually. All of these fees can easily add up to around 3% and are deducted from your account value annually. Variable annuities may also have a surrender period, which will be explained next…
5. Fixed Indexed Annuities (FIA)– These investments typically have no fees whatsoever, so 100% of your money goes to work for you from day one. In place of fees, these annuities use a surrender period. The length of the surrender period can vary greatly and can be matched to the client’s needs. Since no fees were deducted, and since the advisor was paid from company funds and not from your investment, the company wants assurances you will stay invested long enough to allow the company to recoup its expenses and make a profit. For no fee, you get a guarantee of principle, the opportunity to participate in market gains, the guarantee to avoid all market losses, and limited penalty-free access to your money during the surrender period.
6. Fixed Indexed Annuities w/ Income Benefits – These investments operate the same as above but provide an optional benefit. The Guaranteed Income benefits assure that if your guaranteed income depletes your account value, your guaranteed income will continue until your death. The fee for this feature is usually around 1% annually and is deducted from your account. (As with all annuities, the advisor’s compensation is paid directly to the advisor from the annuity company’s operating account. None of the advisor’s compensation is deducted from your money).
There are a lot of other types of investments we could discuss, but these represent the bulk of what is being used in the marketplace today. Here are some observations:
1. When it’s all said and done, the advisor ends up being paid about the same regardless of the investment vehicle used.
2. Some investments offer tangible benefits, like guarantees, for their fees, while others offer esoteric benefits, like advice, for their fees.
3. Fees are not the primary reason for choosing an investment.
4. Beware of the advisor who emphasizes fees over your goals and needs.
5. Ask, what is important to me? What do I want in return for the fees I pay?
I will be back with more good questions for you.