The Great Fee Mystery

Does it ever feel like the world is full of questions but not enough answers? As a society we have grown so used to the lack of answers we begin to accept that is simply the way it is. However, when vague fees and nonsense compromise your investments, would you accept “that’s the way it is” as an answer? My guess is no and if that is the case, you are just like us. In a world with not enough answers, we not only talk openly about the costs of working with a financial advisor, we will present it from multiple angles so we may provide a cost structure to best-suits your needs.

The costs associated with financial advice is often mysterious, sometimes seeming as if it were on purpose. Not that I am suggesting any advisors gloss over the required fee disclosures when meeting with clients, but does the client really leave the meeting with a clear understanding of the disclosure they just signed? A disclosure here, some more legal terms and fine print there…it is what it is…just sign it and move on. The client’s cost is often the advisor’s compensation. Because of this relationship, there is always concern with conflicts of interest. If you feel you are paying too much for financial advice but don’t understand how you’re being charged in the first place, you are not alone. Below we will define some of the most common ways a financial advisor is compensated for their services so you may finally have an answer to one of life’s pesky, unanswered questions.

Fee-Based Accounts (Advisory and Retainer Fees)

The costs associated with fee-based accounts are more straightforward than those of commission-based products. Fee-based accounts are charged either a percentage of the account’s value, known as an advisory fee, or a flat dollar amount, known as a retainer fee. The relative cost predictability and fee consistency of fee-based accounts makes them the most attractive option for many clients. Because the advisor is compensated only by a predetermined fee instead of on a per transaction basis, it can offer the most transparency and flexibility for the client’s investment needs.

$500,000 x 1.00% = $5,000 annual advisory fee

$250/mo retainer fee x 12 months = $3,000 per year

The fees shown here serve as an example of how costs are determined for advisory and retainer fee models and are for illustrative purposes only.

Commission-Based Products

Up until recently, commissions were the primary compensation for most financial advisors. Though commission-based products have fallen out of favor in recent years, these products may still have a place depending upon the client’s situation. With the advisor’s pay riding on which product is being purchased, it is natural to wonder if the product is recommended because it pays the advisor best or if it is truly best for the client. The most commonly used commission-based financial products are mutual funds, with commissions being earned when the advisor purchases them on behalf of the client. It is important to understand how commissions are calculated to determine if paying a commission on your purchases is more cost-effective than other payment arrangements.

Mutual funds purchased in commission-based accounts are subject to sales charges by way of what is known as A-shares or C-shares. The sales charges are charged by the company selling the mutual funds who then kick a percentage back to the advisor in the form of a commission. There are also 12b-1 fees which are trailing charges paid to the advisor for having sold shares of the mutual fund. The more money invested with a fund company, the lower the up-front sales charges become. This is known as a breakpoint. The table below outlines the difference in costs between A-shares and C-shares and how A-share costs are reduced at varying breakpoints.

The fees depicted in this table serve as an example of how costs differ between share classes and are for illustrative purposes only.

In the above example, we can now begin to assess which is the better investment option for your own financial situation. When just starting out and investing $100 per month, you may find that paying 5.75% up front is cheaper than paying a monthly retainer fee. The disadvantage is that you may have access to fewer investment options than one would with an advisory, or fee-based, account.

At the $25,000 level, the client is often below the advisory account minimum for most advisors, leaving only the retainer fee or commission-based model. Retainer fees can become very expensive for smaller accounts as shown in the table below. This essentially limits the client’s options to either A-shares or C-shares if starting out with a smaller account.

The fees depicted in this table serve as an example of how costs are determined and are for illustrative purposes only

Fund Expense Ratios

The expense ratio is the annual fee that all funds or ETFs charge their shareholders. The expense ratio pays for management fees, administrative fees, and operating costs of the mutual fund. Mutual funds typically charge in the range of 0.40% and 1.00% annually. ETFs are typically cheaper than mutual funds and can range between .05% and 0.40% annually. So this means, if you are paying a 1% advisory fee, you may also be paying up to an additional 1.00% or more in fund management fees. Mutual funds are actively managed funds while ETFs are passively managed. Without going into too much detail that just means mutual funds use more manpower and resources to make strategic investment decisions while ETFs are designed to track the performance of a specific market index (i.e. S&P 500). Tracking an index requires fewer resources from a management perspective than having a team of analysts researching multiple sectors of the global economy for investment opportunities.

Transaction Costs

The adage goes, “there is no such thing as a free lunch” and when it comes to trading there are no exceptions. No matter the trading platform, account custodian, fee-only, or commission-based there will always be some sort of transaction cost. It could be a flat fee per trade, a fee per share, or a mixture of the two. Another "more hidden" cost of trading is the Bid/Ask spread. The below image will help illustrate this concept.

In the above example. if you were to purchase the SPY ETF, listed at $272.35 as of the date of this posting, you would actually be purchasing it at the Ask price of $272.37. On the other hand, if you were looking to sell your SPY ETF, you would be selling it at the Bid price of $272.35. In this example, the difference (spread) is $0.02 and this money goes to pay the broker/specialist who physically handled the the trade.

As you can see, financial planning fees can be complex. Each advisor will have a different means of compensations but we hope the above examples answered shed some light on the fees that seemingly lurk in the shadows. We believe in educating and empowering our clients to make the best financial decisions possible. Understanding fees allows us to better control your costs, ultimately leaving more money in your pockets.

The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. Securities offered through Securities America, Inc., member FINRA/SIPC, Betsy Merritt & Tyler Aubrey Representatives. Advisory services offered through Securities America Advisors, Inc. New Break Financial and Securities America are separate companies. Securities America and its representatives do not provide tax or legal advice. It is important to coordinate with your tax or legal advisor regarding your specific situation. Diversification seeks to reduce the volatility of a portfolio by investing in a variety of asset classes. Neither asset allocation nor diversification guarantee against market loss or greater or more consistent returns.