Between the Lines
What to Know When Choosing an Advisor
By Jeff Bland
June 2, 2009
Investing can be a tricky process, which is why many turn to professional advisors for help before venturing into the investment world. While seeking the advice of a professional will help keep your investments on track, understanding what you’re being charged for can be a challenge. When you’re working with a financial advisor, ask yourself “Do I really know how much I am paying in fees?”
If you buy a gallon of milk, there will be a clear and understandable cost. And as you walk away from the store with your milk, there are no additional costs—it’s an easy and simple task. Unfortunately, this is not the same way investments work. What you see isn’t always what you get. The cost associated with investments can be just one of at least three different costs charged to your account. Most financial advisors will provide a portfolio of funds, and with this service you will incur not one cost but three. By understanding these costs, you’ll ensure that you’re not paying for more than what you planned on.
Three Costs to Know
1. The Advisor Fee
The advisor fee is generally expressed as a percent of the assets. While some financial advisors feel it is fair to use an average of 1.25 percent, some firms can be as high as 3 percent per year, according to a 2008 Rydex Advisor Benchmarking Research study. In addition to the advisor fee, you must pay for the funds your advisor recommends, and this is where you will find the two other costs: fixed and variable expenses.
2. Fixed Expenses
The fact is that every mutual fund and exchange-traded fund charges this fee, including even no-load funds. This fee is also known as the expense ratio. This pays for the operating costs of the fund (manager’s salary, research, etc). According to Morningstar, as of September 30, 2008, the average expense ratio for all mutual funds was 1.32 percent per year. However, it is not uncommon to find expense ratios as high as 6 percent.
3. Variable Cost or Trading Expenses
The variable cost or trading expenses does not refer to the commissions you might pay for your advisor to buy investments. When fund managers trade, they incur commissions, just like you or I would. The fund pays a lower commission rate; however, the number of shares traded can be in the millions—meaning the trade costs can be gigantic. This cost is not included in the annual expense ratio nor is it disclosed in the prospectus. To find these expenses, you must look in the funds Statement of Additional Information (SAI).
In 2007, an analysis by researchers at Virginia Tech, the University of Virginia, and Boston College, found the average fund, based on a sample of 1,706 U.S. equity funds from 1995 to 2005, incurred an average annual trading expense of 1.44 percent per year during that period. Keep in mind this is in addition to your advisor fee and the fund expense ratio.
Worth the Costs?
After all of these costs are weighed, I still recommend using an investment advisor. However, you should be informed of what is being charged. One simple way to empower yourself is by looking your advisor in the eyes and asking, “What are the total costs I will incur by working with you?” Ask the advisor to give you a simple breakdown, including an advisor fee, fund expense ratio and fund trading costs.
Jeff Bland is the president of Burrus Institutional Wealth Services. He can be reached at 801-532-0505 or email@example.com
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