What are some of the ‘hidden fees’ that investors pay when they engage an investment adviser, financial planner, or stockbroker?
Here are some of the more common fees that you may not be aware of when you engage an adviser or planner:
- Front-end loads.
Many advisers place client money in funds that charge a front-end load. A front-end load is a charge you pay to compensate the adviser for his service as a salesman of the fund. You might analogize it to a car salesman that makes a commission for each car sold.
Technically the adviser is not charging you directly. Instead, you pay the mutual fund and the mutual fund turns around and pays your adviser. Your adviser is able to tell you that he is not charging you a fee. Technically he’s right because the fund is charging the fee.
You, the investor, shouldn’t be impressed by the nuance. You are still being charged a fee.For example, if the front-end load is 5% and you put $100,000 in the fund, the fund will charge you $5,000 for the “privilege” of investing in the fund. The mutual fund pays most or all of the $5,000 to your adviser as a sales commission. You are left with $95,000 in the fund and an immediate $5,000 loss.
- Back-end loads.
A back-end load, also called a deferred sales charge, is a fee you pay if you sell the fund within a certain period of time, typically 3-7 years. The longer you hold the fund, the lower the fee. A back-end load ties up your money. Mutual fund managers like back-end loads because they force you to stay invested in the fund and impose a penalty if you don’t. As a result mutual funds pay a higher commission or referral fee to your adviser for investing your money in a back-end load fund.
- High expense ratios.
The expense ratio represents the annual ongoing expenses of a mutual fund. Every investor in the fund pays a percentage of his or her invested assets to support the fund managers’ salary, administrative costs, and advertising costs (also known as “12b-1 fees”). For example, if you invest $100,000 in a fund with a 2% expense ratio, you pay about $2,000 per year to support the fund’s ongoing expenses.
- High commissions and transaction costs.
Some advisers use brokers with high commission schedules. It is not uncommon for investors to pay $50, $100, or more for a single trade. Commissions at that level made sense a few decades ago when the broker’s cost of doing business was higher. Fortunately technology has intervened to make brokerage commissions much less expensive. However, many advisers and planners continue to cause their clients to pay oversized commissions, possibly because they derive “kickbacks” or other benefits from the broker. Needless to say, the large commission schedule hurts investor returns.