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The Importance of Understanding Investment Management Fees & Expenses

When individuals are investing, fees are one of the most important things to pay attention to. Over a lifetime of investing the amount of fees paid could easily be hundreds of thousands or millions of dollars over time.

Fees, trading costs, and taxes all eat into portfolio returns and can negatively impact your account balances…

Asset allocation obviously has a lot to do with expected returns but I won’t get into that here. One should start by analyzing their investment portfolios and individual funds.

Resources to Lookup Management Fees and Expense Ratios

Go to Morningstar and look up the fund ticker symbols to see what the annual expense ratios are. This is what the fund charges on an annual basis. You do not see this come out of your account, as it will be baked into your total return.

Other websites include Yahoo Finance or ETF.com for example. Your financial institution is a great resource as well but you usually will need to have an account to access their investment research resources. This can include a firm like Fidelity or Charles Schwab .

Mutual Fund Share Classes and 12b-1 Fees

Be aware of the share class your mutual funds: A, B, C, or I. These will greatly impact how much you’re paying in fees. A-shares typically come with large up-front commissions that are paid to the broker or firm.

12b-1 fees are for advertising costs of the fund. B and C and shares typically have a back-end load or a level redemption fee once you sell, or get out of a fund. Institutional share classes usually have lower expense ratios and do not charge commissions.

RIA vs. Broker-Dealer

Broker-Dealers usually charge a commission to invest in mutual funds or other investment products as perviously mentioned. This how the firm and advisor get compensated, hence the share classes mentioned above. They are in the business of buying and selling securities. They faciliate these transactions for clients and are compensated as such.

There are companies that don’t charge or receive commissions from investments. An RIA (Registered Investment Advisory) firm typically uses low-cost funds with no commissions. RIAs are not licensed to receive commissions unless they are dually registered with a broker-dealer. They will usually charge a fee for assets under management or financial planning fees. They are in the business of providing investment and financial planning advice.

Always ask your advisor how they’re compensated and how their firm is registered.

Annuities and Life Insurance Fees

Annuities and other life insurance products are riddled with fees. It seems like the sales reps almost always forget to mention this. I do not believe in using insurance products as investment vehicles because of the high fees and commissions involved.

If you’re in an annuity or whole life policy be sure to read the details of the policy or contract. Be sure to understand your surrender policy if you’re in an annuity and want to cash out. There can be huge penalties if you get out of the contract, typically within the first 8 to 10 years.

Always ask your advisor how they’re getting paid and what the internal fees are with your investments or insurance. Ask to see statements and have them show you where the fees are coming from.

401(k) & Other Qualified Employer Retirement Plan Fees

401(k)’s will show you the fees you’re paying in the summary plan description. It should show how much the advisor is getting paid as well. This will layout the investment options and expense ratios.

Ask HR if you need a copy or to learn more about the plan. An advisor will help you review your options and fees as well. Sometimes 401(k)s will have brokerage links where an advisor can manage the account for you, or you can do it yourself.

The brokerage link may give you access to a lot more investment options. This will allow you greater flexibility in portfolio construction and possibly pay less in fees.

Fixed Income: Individual Bond Commissions

Individual bonds can be very difficult to know how much you’re paying in commissions. We use bond mutual funds and ETFs where you know the annual expense ratio of the fund.

With individual bonds the commission is baked into the price of the bond, regardless if you’re buying at a premium or discount. The broker usually finds the bond at one price and then will up-charge you when they sell to individuals. Especially if you’re buying in smaller increments.

Large institutions such as mutual funds have the ability to obtain better pricing due to their access to large amounts capital. The bond market can be less efficient and not as liquid as the stock market if you’re investing in junk bonds that are thinly traded. Therefore, this can impact prices and your ability to buy or sell a bond, creating liquidity issues.

At the end of the day be sure you’re cognizant of what is in your portfolio. Pay attention to the fees and who you’re paying. If you have questions or don’t understand something, make sure you ask, or find somebody who can help.

If you’d like an objective second opinion about your finances, please contact Michael Shea, a CERTIFIED FINANCIAL PLANNER™ and owner of True Equity Wealth Management LLC. Email him at michael.shea@trueequitywealth.com or fill out a contact form.

DISCLAIMER
This blog is provided for informational purposes only. Such views are subject to change at any point without notice. The information in the blog should not be considered investment or tax advice or a recommendation to buy or sell any types of securities. Some of our blogs or information therein have been obtained from third party sources believed to be reliable but such information is not guaranteed. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor’s financial situation or risk tolerance. No reliance should be placed on, and no guarantee should be assumed from, any such statements or forecasts when making any investment decision.

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