Three Critical Questions About Adviser Fees

Posted on May 22, 2013 at 11:42 AM PST by

Retirement savers have a lot on their plate these days. A long, slow recovery is making it harder to believe in stocks even as they hit new highs. Meanwhile, bond yields are low, in some cases negative after inflation.

Tax laws are changing, government is deadlocked over the debt and there seems to be no safe place to turn, on or off Wall Street.

To top it all, there’s the growing discussion on the matter of adviser fees. When markets zoomed upward reliably in double-digits, few seemed to care what they paid money managers in adviser fees. Now, every penny counts.

adviser fees

One big-wheel wealth management firm is coming completely clean on adviser fees, detailing their strategy of telling the painful truth in a fascinating article in The New York Times. They say that their firm reveals the actual dollar cost of management on an annual basis.

“By expressing it in dollars, that makes a real impact on clients,” one manager at the firm told the newspaper. “Most advisers talk in percentages or, worse, basis points, and no one knows what a basis point is.”

He’s got the right idea: People saving for retirement, whether they have $40,000 or $4 million, really don’t understand how they are charged, why and when. So let’s break adviser fees down.

1. How you are charged. Most money managers talk in “basis points” because it’s the language of finance. A simple synonym for basis point, one which might make more sense to ordinary people, is “a tiny fraction of 1 percent.”

Take 1% and cut it into 100 pieces. Each of those tiny pieces is a basis point. So, 100 basis points is 1% while 50 basis points equals 0.5%. On a $100,000 investment then, a 50 basis point fee comes to $500 per year.

Easy, right? Except people often don’t understand the whole picture on adviser fees, which involves adding up charges from several directions. The manager might be charging you 1%, but the underlying funds he or she buys on your behalf could easily be charging another 2% for that portion of your money, obscuring a rock under which lives another nest of poorly explained fees.

Key questions to ask: Tell your manager to add up all the fees on your account. If you don’t have an account yet, ask for a breakdown and total on fees for a sample account. Get it in dollars per year for a given balance, say, $100,000 or $1 million, any number that helps you make an apples-to-apples comparison.

2. Why you are charged. Money managers have to eat, of course. But there’s no good reason to buy the most expensive fund on the market in order to achieve a simple outcome. If you have an actively managed fund in your portfolio whose purpose is to “beat the benchmark return” of some well-known index, does it? And does it beat the benchmark after subtracting the fund’s fees?

You might want to know why your manager owns this fund, if it can’t achieve its stated goal with any consistency. In comparison, index funds and exchange-traded funds won’t beat their benchmarks. But they won’t lag by much, either, given their tiny fees.

Key questions to ask: Why are the funds I own worth the adviser fees I clearly pay to own them? Do you benefit from buying them on my behalf? Are there efficient alternatives?

3. When you are charged. Finally, you have to consider the impact of trading commissions. Getting in and out of individual stocks can be pretty cheap in a tax-sheltered retirement account, but if your manager does it daily, well, that adds up. He doesn’t pay for the trading, you do.

Likewise, mutual funds cost a flat amount to trade, generally higher. If your manager is trading in and out of mutual funds as if they were stocks, that’s a serious cost burden for you.

Key questions to ask: Are you compensated when a commission is generated? What is the “turnover” (a measure of trading frequency) of your average portfolio under management?

Your adviser fees cheat sheet

Here’s your cheat sheet. The correct answers to the above for long-term retirement investors should be:

1. Adviser fees of less than 1%, all in.

2. You own the least expensive, most passive funds.

3. We receive nothing for trading your account and do so only when absolutely necessary to rebalance.

You may like these other MarketRiders articles: