How to Tell If You're Wasting Money on Hidden Financial Fees
Kyle Ryan, executive vice president at Personal Capital, shares advice on spotting hidden fees that many people don't notice when working with their financial advisor. He also provides three tips to determine whether their financial advisor is acting in their best interest.
You work with a financial advisor because you believe his services can optimize your investments. But have you read the fine print of the associated products and financial fees? They might be hurting your portfolio.
An annual fee paid to your financial advisor of 2-3 percent might seem like a small price to pay for the security of knowing that your money is in capable hands. However, compounded over the course of a lifetime, those percentages can build up to hundreds of thousands of dollars, according to a report Personal Capital published last year.
Those fees and expense ratios vary greatly across firms and even within the same organization, and they often appear as indecipherable industry jargon buried in the fine print. Moreover, if you are diligent enough to hunt them down, tracing them through your account is yet another beast altogether.
Deciphering the Most Common Hidden Fees
With investments like mutual funds and exchange-traded funds (ETFs), you’ll typically pay yearly service and management fees—and over the course of several decades, those fees can amount to thousands of dollars. There are management fees, advisory fees, service fees, and even 12b-1 distribution fees (which are basically just marketing costs) that are often buried so deep in a fund’s reports that it’s extremely difficult for the average investor to decipher exactly what she's paying.
Some costs are valid if the service is achieving your goals, but others are just a waste of cash.
When it comes to mutual funds and ETFs, there are typically three main (and often hidden) costs: the expense ratio, load fees, trading costs, and market impact.
The expense ratio is the main fee you’re charged for asset management, and it usually ranges between 0.1 percent and 2 percent per year. Load fees are basically commissions to the broker who sold the mutual funds you’re investing in. While ETFs don’t have load fees, they’re quite common with mutual funds. Trading costs, or commissions, are what you pay when buying or selling a fund within your account. ETFs generally don’t have internal trading costs that are passed on to the client, but you may pay commissions to trade them within your account. Finally, market impact is the hidden cost that occurs when a large fund buys a stock, drives up the price, and then sells it and drops it down again. This affects the stock’s performance and can seriously impact your investments.
These fees can be worth paying, but it depends on the quality and level of service. While some advisors offer asset allocation and financial planning, others simply choose stocks or funds and don’t offer many other benefits. Moreover, many advisors charge high fees and then buy active mutual funds with additional high fees on top, so you get hit twice.
Exposing Hidden Fees
Many investors believe that the more they pay in fees, the better service they are receiving.
In fact, in 2017, we issued a poll showing that 32 percent of people believe that higher fees will result in higher returns. However, that’s not always the case, and it’s more important than ever that investors don’t let financial institutions take advantage of them.
Many firms downplay the impact of fees on your investments by burying them in the fine print, leaving investors completely unaware that they’re potentially losing hundreds of thousands of dollars over a lifetime. For example, if you are maxing out your 401(k) every year of your career, the average additional amount lost to fees adds up to more than $400,000 over the course of a lifetime. Even a 1 percent difference can cost the investor an extra $240,000 in fees over the same time horizon.
Even worse, due to fees charged over time, that doesn’t completely capture the amount you lose in total returns because the investment doesn’t have time to grow and compound. In short, the total amount you lose at a 3 percent fee versus a 1 percent fee — including both fees and foregone returns — is more than $740,000 over your lifetime.
How can you take better control of your financial future? Have a conversation with your financial advisor about the products he uses and the associated fees he charges. Some costs are valid if the service is achieving your goals, but others are just a waste of cash. Here’s how to determine whether your financial advisor is acting in your best interest:
1. Demand Transparency
Investors need to have ownership over their finances, and that means you need to be able to tell whether the financial advice you’re receiving from your advisor is really in your best interest or whether he's just trying to sell you services you don’t need.
Find out how your advisor is compensated. Is he incentivized by compensation from mutual fund companies on products he sells to his clients, the amount of cash in his clients’ portfolios, or the frequency of trading transactions? Also, do some research to find out how invested the company is in technology. Some firms don’t have an adequate investment in technology, meaning they can’t provide a transparent snapshot of your whole financial situation and, therefore, might not be able to give you the best advice.
2. Analyze Fee Schedules
Fees often aren’t set in stone and can vary month to month, so by studying your fee schedule, you’ll have a better understanding of how much you’re paying. Talk to your financial advisor about the specific fees you’re paying and how much you’re charged, and you might be able to reduce or eliminate some of them. In some cases, it might even be helpful to increase your investments in order to reach a fee break point and reduce your rate.
3. Shop Around Before You Commit
You wouldn’t buy the first car you see on the lot, so don’t commit to the first financial advisor you find. Shop around for financial advice, and do your research to make sure you’re really making the most of your money. If the advice you’re receiving isn’t worth what you’re paying in fees, find someone better. Your financial future is up to you, and the longer you wait to take control of it, the more money you might lose in the long run.
According to MarketWatch, over 60 percent of Americans don’t understand how much they pay in fees. If you don’t know exactly what you’re paying, it’s important to do your research and ask the right questions. If you don’t, you could be risking hundreds of thousands of dollars and a secure financial future.
Kyle Ryan is executive vice president at Personal Capital, where he is responsible for all of the company's advisory personnel and is a member of the Investment Committee. He has overseen the growth of Personal Capital from zero assets under management to currently over $7.5 billion. Prior to Personal Capital, Kyle held senior management positions within Merrill Lynch and Fisher Investments, a $50 billion AUM asset management firm. He was named to the 2014 InvestmentNews 40 under 40 list for his contributions to the financial advisory industry, and he received his Bachelor of Arts with College Honors from the University of California, Los Angeles. Kyle resides in Danville, California, with his wife and four children.