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Pulling Back  the Curtain: Find Out How Investment Fees & Expenses Really Work

Pulling Back the Curtain: Find Out How Investment Fees & Expenses Really Work

July 31, 2018

The obscure nature of financial rules and regulations provides investment companies, with an information advantage when selling products and services to clients.  Most investors do not understand the jargon and complexities that define investment products as a whole and what’s most misunderstood are fees and expenses.  In fact, it’s safe to say that many investors have no idea how much they are paying, what kinds of fees are being charged, and how fees and expenses erode future retirement savings.    

Many investment products are complex and when selling products to clients, investment providers can leverage their position by taking a “leave it to the pros” attitude when discussing products and too often, the subject of fees and expenses is omitted completely from the conversation.  This results in clients unknowingly giving up control of how their money is being managed and how much they’re paying. 

Fees and expenses can hide in many areas within investment products and, to understand them better, it’s good to know the types of investment providers that are in the market and the types of products that are sold. 

 Below is a summary:

 Registered Representatives (RR) and Brokers:   Generally speaking, Registered Representatives or Brokers are securities licensed individuals that work for brokerage companies, banks, mutual fund companies, or insurance companies.  These individuals provide advice under a “suitability” standard where divided loyalties between the company and their customers can exist.  Under a suitability standard, conflicts of interest may exist without consequence and brokers or RRs are not required by law to recommend the best products in the marketplace so long as the product meets the suitability criteria.     

 Investment Advisor (“IA”):   Investment Advisors operate under a “fiduciary” standard of care and have undivided loyalty to clients. IAs must also avoid (or disclose and manage) conflicts of interest and, by law, must put the best interests of clients ahead of all else.  As fiduciaries, IAs must apply the skill, diligence, prudence, and good judgment of a professional when making investment recommendations. 

Insurance Agents:  Insurance agents are insurance licensed and generally are not regulated by any self-regulatory agency, such as FINRA or the SEC.  That said some insurance agents are able to sell certain products that have ties to financial markets so it can be portrayed as if an insurance agent is providing investment advice.  Insurance agents are not held to any standard of care under current regulation or law and underlying conflicts of interest exist when they sell certain products.  For example, an insurance agent can sell annuity products as simple to understand, lucrative investments that have no fees, no risk, and can only go up in value, but in return for their sales efforts agents can receive huge commission payments which brings into question whose best interest is first.    

In reality, annuities are complex and in many cases don’t do what they promise.  Also, fees charged by annuities can be very confusing and annuity investors should learn the types of fees charged.  Most annuities charge a contract fee (called M&E or Mortality & Expense) which can be anywhere from 1%-1.5% per year.  Next, there are charges for additional benefits such as income or enhanced death benefits which can range between 1%-2% per year and, if there are mutual funds in an annuity, those funds charge fees as well – which can add another 1%-2%.  Annuities can be very expensive.

With mutual funds, there are two types of expenses to watch for…First, there are up-front sales loads that can range from 1% - 5.75%.  For example, if $100,000 is invested into a mutual fund and a 5% sales load is charged, only $95,000 gets invested ($5,000 is paid as commission).  The second level of cost with mutual funds is the expense ratio which is an ongoing annual percentage that’s charged against the money in the fund.  Expense ratios can vary, but are generally charged at a rate of 0.75% - 2.00%.    

 In a stock transaction, you should be aware of any commissions charged when buying or selling.  Typically, when a broker is making stock trades, commissions are charged on both buys and sells.    

 Bonds can be tricky.  When purchasing bonds investors pay a mark-up on each bond purchased.  For example, if a bond is purchased at $1,010, the actual price paid may have been $1,000 and the mark-up or commission paid to the broker is $10/bond.  When selling bonds, the opposite is true and a mark-down reduces the sales price of each bond to cover costs of commission. 

 In an advisory investment program, Investment Advisors charge an annual percentage based on the value of your account.  This fee is usually visible and no other commissions or fees are charged by the IA.  The average annual advisory fee could range from 0.50% to 1.50% depending on account size. 

 Transparency is the key to understanding investment costs and all investors should know exactly how much they are paying and understand how fees affect long-term investment results.  The chart below shows how paying less can make a huge difference over longer periods of time (Assumes $750,000 inception value, an actual fee paid of 1.92% and an assumed fee of 1.00% creating $384,834.43 in savings over a 20 year period):


(This is a hypothetical example and is not representative of any specific investment. Your results may vary.)

At Capstone Wealth Management Group, LLC, we are Investment Advisors operating under a fiduciary standard and we believe in complete transparency and fairness when quoting our fees.  If you have investments like those mentioned in this blog post and don’t know how much you’re paying, let us help you.  At no cost or obligation, we can provide you with an “X-Ray” of the fees that you’re paying and pull back the curtain on the investment products in your retirement nest egg.  

Disclosure: (Investing involves risks including the possible loss of capital.)