Many investors ask about the cost-benefit analysis of financial planning. Fee-only advisors can claim their compensation is straightforward and easy to understand. In contrast, commission-based advisors, due to their complex billing, are hard pressed to provide you with your true costs. Thus, you may already be paying more than you realize. Many financial professionals […]
Many investors ask about the cost-benefit analysis of financial planning. Fee-only advisors can claim their compensation is straightforward and easy to understand. In contrast, commission-based advisors, due to their complex billing, are hard pressed to provide you with your true costs. Thus, you may already be paying more than you realize.
Many financial professionals earn their living through the products they sell. They load their investment products with commissions and then find gullible investors to buy them.
The most obvious commission-loaded mutual funds are A-Shares. A front-end sales commission is deducted from whatever money you put into the fund. The salesperson posing as your advisor pockets this charge, often around 5.75 percent.
If you don’t want A-Shares, you can buy B-Shares that have a back-end load, sometimes called a surrender charge. If you sell the investment early, you must pay this charge, which usually starts at several percent and then gradually decreases.
The surrender charge is touted as a feature because it discourages you from tapping into your savings. Any financial product with a large surrender fee has financial hooks.
Financial hooks hold you hostage to a poor investment idea. While you are captive, you experience higher than normal annual fees and inferior service. Without a way to extricate your investment, you are stuck for years.
Annuity products work similarly to B-Shares. They often have a seven-year surrender charge coupled with much higher than normal annual expenses, often exceeding 2 percent because of the layered life-insurance product fees.
Hedge funds can also have a lockup period, where you are not allowed to withdraw money from the fund. They typically charge 2 percent, plus 20 percent of any gains in the account.
For customers who don’t want to pay a sales commission and want to sell their investments without paying a fee, mutual-fund salespeople have a fund class called C-Shares. However, these C-Shares have a continuous fee, so customers are gouged every year. For example, consider the Growth Fund of America C-Shares (GFACX) with an expense ratio of 1.45 percent. Compared to the Vanguard Growth Index Admiral Shares (VIGAX), you would be paying 1.36 percent extra every year for inferior returns.
Mutual-fund salespeople are adept at determining what you are wary about and then steering you to one of the other choices. They get paid no matter which of the three you choose. But all three choices are a bad idea.
Less obvious, but more common than commission-based salespeople, are so-called fee-based advisors. “Fee-based” isn’t the same as “fee-only.” We contend the term fee-based was created by commission-based advisors to confuse consumers.
There is no “fee-based” terminology when a firm files with the U.S. Securities and Exchange Commission (SEC). The SEC requires firms to specify all the ways they are compensated. Fee-only advisors may check “a percentage of assets under your management,” “hourly charges,” or “fixed fees.” But, what they won’t check is “commissions.” You can determine if advisors are fee-only by checking their SEC filing to see if they have checked “commissions.” If they accept any commissions, they are not fee-only.
We believe “fee-based” is a way for firms to pose as fee-only advisors. Their campaign to muddle and mislead is working. Most clients are confused about these differences between financial advisors and don’t care to learn. Rather than call these firms “fee-based,” we describe them as “commission-based.” We invite others in the financial news industry to adopt this more transparent terminology.
Fee-based advisors are sneaky. They can charge a much smaller fee than a fee-only advisor, while actually taking more of your money via commissions.
Many people pick their financial advisors based on social relationships without examining how the advisors are compensated and the quality and objectivity of their advice. As a result, they may not even know what they are paying in the layers of fees and expenses on their investment choices.
Savvy investors know what they are paying for financial products and advice. It is also critical to have a financial advisor who has every incentive to reduce those costs where most appropriate.
David John Marotta is president of Marotta Wealth Management, Inc., which provides fee-only financial planning and wealth management at www.emarotta.com. Megan Russell studied cognitive science at the University of Virginia and now specializes in explaining the complexities of economics and finance at www.marottaonmoney.com