We’ve written about why investment fees matter before. And since fees can take a big bite out of your investment returns over time, it’s important to understand what you’re paying and how your current advisor earns their keep.
Financial advisors today primarily come in one of two flavors. The first is paid at least in part by selling products and earning commissions, in addition to charging their clients a management fee. The second is paid solely through a management fee and doesn’t sell products or earn commissions. (For more about these competing business models, see “The fee-only & fiduciary difference.”)
How advisors can be paid
- Management fees – Most advisors today charge a management fee. The industry average is slightly over 1% of your account value per year. Some advisors are lower, and some are higher, but most fall in the range of 0.75% to 1.25% per year. Fee schedules are typically tiered, meaning the more assets you have the lower the percentage fee you will be charged. (You can see our fee schedule here.)
- Sales loads – A fancy term for commission. These are paid to the advisor by a mutual fund company when shares are purchased or sold. This commission can be as high as 8%, meaning if you invest $100,000 the advisor gets to keep $8,000 and they invest the remaining $92,000 for you. This is an expensive way to gain access to a mutual fund in our opinion. Most sales loads are in the 3% to 6% range.
- Expense ratios – Mutual funds have their own internal operating costs, like a management fee. These can vary from 0.03% to 3% or more per year, depending on the product, vendor, and strategy. It’s in your interests to keep these expenses on the lower end.
- Revenue sharing – Some mutual funds charge a higher expense ratio and give a portion of this fee back to the advisor. For example, a fund might charge 1.25% and let the advisor keep 0.50%. The industry term for this sharing arrangement is a 12(b)-1 fee.
- Margin loans and lending activities – Some Wall Street firms compensate their advisors for clients borrowing money against their brokerage account, what’s known as a margin loan. This generates margin interest for the brokerage firm and the advisor can share in this revenue stream at some firms.
Separate fees for financial planning and other services provided are common in our industry as well, so the above list is not all-inclusive. Full disclosure: Pittenger & Anderson is solely paid by a transparent management fee when it comes to investment management. If a client wants to hire us just to do a financial plan for them, we charge a flat fee of $2,000.
How to calculate your all-in investment costs
To compare one advisor’s fees to another’s you’ll want to make sure you have the right data. What you want is an apples-to-apples comparison. You need to account for the advisor’s management fee, the investment costs (expense ratios), and any sales loads and/or revenue sharing that may be going on. Here’s a look at three hypothetical advisors:
Obviously, fees are just one aspect of analyzing if an advisor or firm is a good match. You’ll want to assess their areas of expertise, what additional services they offer, and how their personality and yours mesh. (See also: 12 ways an excellent financial advisor adds value.)For a hypothetical $1 million investment account, the difference in total fees between Advisor #1 and Advisor #3 over 10 years amounts to more than $250,000. This example assumes the same investment return over this time.
If you’d like us to do an apples-to-apples comparison of the all-in costs of your accounts where they’re at now with how P&A would manage them, please connect with us. It pays to know what you’re paying.
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Pittenger & Anderson, Inc. does not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction. Additionally, the information presented here is not intended to be a recommendation to buy or sell any specific security. To learn more about our firm and investment approach, check out our Form ADV.