You’re Paying Way Too Much to Invest
You don’t know how much you’re paying in investment costs. (I’ll explain why in a moment.) But if you are using a full-service broker or insurance agent, it’s almost certainly way too much.
Take mutual funds, for instance.
Broker-sold funds don’t just have front-end and back-end loads (commissions), they also come with 12b-1 fees attached. For the uninitiated, that’s additional compensation paid annually to the broker that sold you the fund.
On top of loads and 12b-1 fees, each fund charges management and administrative fees and has to cover security spreads and trading costs. High costs are just one of the many reasons that more than 95% of actively managed funds can’t beat an unmanaged index fund over the long haul.
You can’t find shelter in broker-sold index funds either.
Unless it’s an exchange-traded fund (ETF), it almost certainly has much higher costs than ones offered by big no-load families like Fidelity, Vanguard or Charles Schwab.
Ignorance Is Expensive
Of course, mutual funds and their high fees are only one of the ways you’re paying through the nose. There are expensive whole-life policies (which I covered in this column), annuities with their high mortality expenses and surrender penalties, stock-trading commissions, annual wrap fees, and so on.
In a recent op-ed piece in The Wall Street Journal, Burton Malkiel noted that from 1980 to 2006, the U.S. financial services sector grew from 4.9% to 8.3% of GDP.
Most of that jump represented increases in asset-management fees. Yet even though most clients get no performance advantage from these higher fees - quite the opposite, in fact - few complain for a simple reason.
They don’t know how much they’re paying.
Don’t get me wrong. The SEC requires disclosure of investment costs. But the fees are buried inside of legal forms, account opening documents and inch-thick prospectuses.
For example, my father-in-law Tony used an investment advisor who recommended an expensive family limited partnership and filled it with broker-sold investment products. I asked Tony if he had any idea what this was costing him.
He shrugged his shoulders.
“Ask him,” I said. “I’ll lay serious odds that you never get a hard number.”
He disagreed. He said his advisor was a good guy and that he’d get the information.
But he didn’t. His broker’s response to the first inquiry was a gentle brush-off. “Tony, don’t worry. I’m taking good care of you here.”
A further push for a written accounting of total expenses paid netted a more forceful response. “Tony, your costs are reasonable. I’m doing a good job for you. What’s the problem here?”
The problem, of course, was that Tony was getting bled dry - and he never did find out what he was paying in total costs.
He did know, however, that after more than a decade the partnership still wasn’t worth any more than what he started with. Set-up fees, maintenance fees, accounting fees and investment costs were devouring his entire return.
“And the final kick in the ass,” said Tony, “was he charged me $60K to liquidate the partnership. The returns I had planned for my kids went entirely to my advisor.”
This story is not unusual. Most clients don’t ask their advisors for a full accounting of costs. So most advisors don’t provide them.
This doesn’t mean your advisor is a bad guy (or gal).
In my experience, most stockbrokers and annuity salesmen are trying to do a good job for their clients. And they have been well trained to explain the benefits of what they offer. (Even if it often means glossing over the drawbacks.)
If your advisor doesn’t provide a ready answer for how much you’re paying in total costs, it’s generally because he has no idea himself. After all, to provide you with a hard number, he’d have to dig out every prospectus for every product, calculate the total costs paid for each, then add them to the trading commissions, loads and wrap fees you’re also paying.
If you find this a little surprising, it may be because you’re unaware how much pressure your advisor is under to convert a percentage of client assets into firm assets. (Although he or she is well-incentivized and compensated for the task.)
What is the solution? The first, of course, is to manage your money yourself. If you don’t feel qualified, you might read my first book, The Gone Fishin’ Portfolio, a primer in how to manage your money in a sophisticated way with minimal costs.
Of course, certain people truly need an investment advisor.
They may be too emotional to effectively handle the market’s roller-coaster rides. Some lack a thorough understanding of basic investment concepts. Others are too busy traveling or running a business. And some, quite frankly, just don’t want to fool with it.
In this case, you might opt to use a registered investment advisor who charges a reasonable fee and invests through a discounter like Schwab or Fidelity. This prevents you from getting into an adversarial transaction-based relationship.
Whatever path you take, know and understand your investment costs. They may be subtle. They may be hidden. But like termites gnawing away inside an antebellum mansion, they can do enormous damage over time.