November 11, 2021
5 minutes to read
Source / Disclosures
Disclosures: Mandell and Peelman do not report any relevant financial disclosures.
Survey data shows that, in general, investors do not understand how much their advisers charge for their services.
This is clear from a recent survey by State Street Global Advisors and another by Rebalance IRA, which found that more than half of Americans mistakenly believe they pay no or minimal fees to manage their accounts. of retirement. In addition, SEI Investments Company conducted a survey of the affluent masses 5 years ago and found that 38% of them were wrong or confused about how they pay their advisers. Finally, Cerulli Associates and Phoenix Marketing International published a survey 10 years ago, which found that nearly two in three investors in the survey were confused about how they pay their advisers.
David B. Mandell
Why the confusion? The financial services industry needs to take responsibility and do a better job of disclosing fees. While we may not be able to reform the entire industry with a single article, we will attempt to clarify the topic and answer some of the most common questions.
Three remuneration models
How are advisors paid? The financial industry has three basic models for the remuneration of advisers.
- Fees only: Advisory fees based on a percentage of assets under management. Advisory fees typically range from 0.5% to 2% of the amount invested; the rate is generally influenced by the size of the asset and the services provided.
- Commissions: Selling costs or transaction costs related to the product sold to the investor. There is a risk of conflict of interest: a broker might be tempted to recommend an investment with the best personal return.
- Fees: Advisors receive remuneration from one or the other model. The advisor can choose the method of payment or can even offer the client the option of determining how they want to pay for their advice.
Investors are often uncomfortable discussing fees and asking how an advisor is paid for the services provided. But discussing fees with your advisor is not unreasonable. In fact, it should be encouraged and part of any routine review of your financial plan. Your advisor should be able to provide a clear and concise description of how they are paid. If your advisor can’t clearly explain their fees and compensation, you should reassess the relationship.
In addition to the fees charged by your advisor, you may have to pay additional fees as an investor. Whether you use an advisor or not, you probably pay several of the following fees:
- Expense ratio: Mutual funds and exchange traded funds have an expense ratio. This is usually a small percentage of your invested assets. Revenue sharing agreements may exist, especially with discount brokerage firms. High expense ratios are one of the most common ways to quietly compensate brokers.
- Transaction fees: your account is debited each time you buy or sell. Such an arrangement is common in the traditional brokerage model. This charge is also known as commission.
- Plan Fees: Common in 401 (k) or company sponsored retirement accounts, your plan provider may charge these fees for holding your assets or providing plan administrative services.
- Packing Fee: Common in a brokerage model, a broker can invest your funds in a basket of individual stocks and you will pay a fee to a third-party manager. A portion of these expenses will be passed on to your advisor as compensation.
- 12b-1 Fees: Evaluated by a mutual fund, fees pay a broker or brokerage firm and are paid directly by the fund company.
- Sales charge or redemption charge: The sales charge is taken from your initial investment and passed on to the broker. An ultimate redemption charge may be assessed when an investment is not held for a predetermined period. Redemption charges are typically tied to 12b-1 fees or a high-fee class of mutual fund shares. Redemption charges are created to ensure a minimum rate of return for the broker, allowing the investor to bypass the initial charges on the investment.
The different types of fees can be confusing, so it may be worth going through a few scenarios.
Example: Client A contacts his broker and expresses interest in investing $ 50,000 in US growth stocks. The broker invests the client’s assets in Fund XYZ, which charges a sales charge of 2.75% with operating expenses of 0.68% per annum ($ 340 on a $ 50,000 investment). The client will immediately pay a one-time transaction fee of $ 1,375 in addition to the recurring fund management fee.
Client B contacts her registered investment advisor with the same request. The Investment Advisor buys an ETF with a gross expense ratio of 0.18% ($ 90 per year on a $ 50,000 investment) and pays no commission on the transaction. This client pays her advisor a management fee of 1% of assets, which equals $ 500 per year on $ 50,000.
In our realistic example, the entry fees and higher fund charges paid by client A are large enough that it takes almost 6 years of commitment to that fund family before this commission equals the sum of the advisory and ETF fees paid by Client B.
What about the discount brokerage model? How might the revenue sharing agreement impact the cost of your advice?
Example: Discount brokerage firm XYZ offers to manage client assets at a reduced cost of 0.8% of assets under management for client A. XYZ representative buys $ 150,000 of shares at retail from a bond fund with an operating expense of 0.75%. The representative does not receive any remuneration for the choice of this fund; however, his company (XYZ) receives revenue sharing directly from the fund company. A registered investment advisor for client B charges 1% for his services and purchases institutional shares of the same fund with an operating fee of 0.46%. Registered Investment Advisors often have access to the lower-cost iShare offered by certain mutual fund families. In this scenario, the “discount” brokerage relationship results in a slightly higher cost to Client A due to the hidden revenue sharing, despite lower management fees for their service.
The full list of fees and expenses that a physician could pay their advisor is long. It’s easy to see why many investors are confused and frustrated with their attempts to determine the cost of their advisory relationship. Nonetheless, it is essential that all investors, including physicians, clearly understand what they are paying their financial advisers.
You can start by asking three simple questions: What am I paying you to manage my assets? What are the combined charges for my underlying investment products? Do you receive compensation for any of the investments you buy on my behalf? This should give you the information you need to understand what you’re paying for.
If you do not receive answers to these questions, Groupe OJM’s wealth management team is willing to perform a fee audit to help you understand what you are paying your advisor and if the amount is reasonable. Authors welcome your questions.
For more information:
Wealth Planning for the Modern Physician: From Residence to Retirement and Wealth management made easy are available for free in print or electronic download by texting HEALIO at 844-418-1212 or at www.ojmbookstore.com. Enter code HEALIO at checkout.
David B. Mandell, JD, MBA, is a lawyer and founder of the wealth management company OJM Group www.ojmgroup.com, where Bob Peelman is a partner and director of Wealth Advisors. You can reach them at [email protected] or 877-656-4362. You should seek professional tax and legal advice before implementing any strategy discussed here.