Advisors, brokers, planners, bloggers, vloggers, Fin Twit experts, and other pontificators are praising the benefits of their own fee models while bashing all others. Strong opinions about whose fee schedule is best is a common thread. At the end of the day, however, a fee is a fee regardless of how it’s charged.
Firms may combine fee platforms or institute pricing tiers with minimum fees. For example, advisors may bill you hourly for their financial planning services while charging you an asset management fee.
One of my clients has been hounded by a stockbroker who has been trying to sell her an annuity. He told her the purchase would not cost her anything. After some research, I found out that he was going to receive a 5% commission.
Several years ago, an insurance agent approached me about buying a whole life insurance policy with an annual premium of $100,000. I was also told I wouldn’t incur any out of pocket expenses or fees. He was going to make $55,000 if I had purchased the policy.
If a broker tells you it won’t cost anything, you’re probably going to get fleeced.
Fees are confusing, especially if they’re called something else. It’s all semantics. Here’s a guide to help you navigate the murky waters of fees. This will help you identify the various types you might incur when you’re meeting with a financial professional or reviewing your account statements.
Commissions. If you buy or sell a stock, a commission will be added to or deducted from your trade. Bonds will also trade with a commission ranging from $1 to $30 per bond. If you purchase 100 bonds ($100,000) and you’re charged $10 per bond, your fee will be $1,000. This is referred to as a markup or markdown. Exchange traded funds and options will also trade with a commission. The more your broker trades, the more commissions they’ll earn.
Front End Load. Mutual funds with a front-end load will have commission rates ranging from 1% to 5% or more and it will be deducted from your purchase. If you invest $100,000 into a fund with a 4% front-end load, your fee will be $4,000, so $96,000 will be invested. The most common type of front-end loaded mutual fund is referred to as an “A” share.
Back End Load or Deferred Sales Charge. Funds and annuities with a deferred sales charge will charge a fee if you liquidate early. A declining sales charge is applied based on the number of years you own your holding. A fund may have deferred sales charge that declines over five years where 5% is deducted the first year, 4% the second year, 3% the third year and so on. If you invest $100,000 into a fund with a deferred sales charge and you sell it in year three, the fund company will deduct 3%, or $3,000 from your proceeds. The most common share class with back end loads are “B” and “C” shares.
Wrap. A wrap account will charge a percentage based on your investment but not charge a commission for your trades because the commissions are wrapped into the fee. Wrap accounts are popular with brokerage firms. They’ll offer you an investment account that owns 50 to 70 stocks or more. Depending on the size of your investment, you may own 2 to 3 shares of a company and If you were paying commissions, the fees could climb quickly. I worked for a large brokerage firm several years ago and our wrap-fee program charged clients 3% per year – an extremely high fee.
AUM. The asset under management fee model is popular with Registered Investment Advisors. An advisor may charge you a fee of 1% on the assets they manage on your behalf. The fee drops with the more assets you have under management.
Retainer. A retainer fee model will give you access to an advisor or planner for a specific project or timeframe, but it may not include managing your assets. It’s similar to an a la carte menu at a restaurant.
Flat Fee. Your fee is flat, or fixed, regardless of your asset level. This model favors large accounts and punishes smaller ones. Advisors will charge a flat fee for financial planning and investment management services. This fee differs from the retainer model because the relationship is intended to be long-term.
Hourly. This model works well if you want a limited scope offering or a one-time analysis like a second opinion. It also appeals to investors who want to pick their own investments but want guidance with their asset allocation or financial plan. Advisors may charge $250 to $500 per hour to create a financial plan, review your investments, or give you guidance on a special project.
Subscription. This is a relatively new model primarily aimed at millennials or high-income earners with little assets. A fee is charged based on your income or net worth and it’s billed monthly, like a car payment. Services may include budgeting, cash flow planning, debt reduction, 401(k) guidance, and investment selection.
Hedge Fund. Hedge funds typically have a 2 and 20 model. They’ll charge you 2% on your assets and receive 20% of your trading profits. For example, if you invest $1,000,000 and it grows to $2,000,000, your hedge fund will earn 2% on $2,000,000 and receive $40,000 in fees. They’ll also earn $200,000 on your trading profits.
Regardless of where or how you purchase a mutual fund, exchange traded fund or annuity, they’ll have ongoing fees and expenses. Mutual funds and ETF’s have operating expenses (OER) and the fees vary wildly. Mutual funds may also have a 12b-1 fee, charging you another .25% on top of the OER. An annuity has fees for mortality, riders, administration, and investments – to name a few. Annuity fees can climb to 3% or more. Individual stocks, bonds and options do not have ongoing fees or expenses after they’re purchased.
Fees come in all types of flavors, so pick one that works well for you and your family. If you’re concerned about fees, then open an account at T.D. Ameritrade, Fidelity, Vanguard, E*Trade, or Schwab and only buy individual stocks, bonds or low-cost index funds. The commissions and fees will be low so long as you don’t day trade your account.
Fees are important, of course, but it’s more important to work with an advisor you trust. One who puts your interest firsts and acts in a fiduciary capacity is recommended.
What about our fees? We charge .5% ($5 per $1,000) for assets under management which includes a financial plan. Our stand-alone financial planning fee is $800. Good conversation, fellowship and bad jokes are free.
In the long run, we shape our lives, and we shape ourselves. The process never ends until we die. And the choices we make are ultimately our own responsibility. ~ Eleanor Roosevelt
June 25, 2019
Bill Parrott, CFP®, CKA® is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose.
Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation.