When it comes to assets that involve risk, you cannot escape fees. The fees also become more difficult to find. Unfortunately, investing in securities often carries both disclosed and undisclosed fees and commissions. However, by understanding what you are paying now, you will have a better idea of the type of value you are receiving. Let’s dive into some of the more common risk-type investments so that I can show you what you are really paying to own each investment.
Mutual funds may be the most common risk-type investment. They might also be the most expensive. The most common cost in a mutual fund is the expense ratio, the standard measure of how costly a fund is to own. In fact, according to Morningstar, the average expense ratio is estimated at 1.31%. These costs are paid to the portfolio manager.
However, it is the undisclosed costs that can make a mutual fund 2-3 times more expensive than the advertised expense ratio. Mutual funds also have brokerage commissions, bid-ask spreads, opportunity costs, and market-impact costs. Brokerage commissions are paid to the firm that sells you the securities. Bid-ask spreads estimate the gap between the lowest price someone is willing to pay for said security and the highest price. Market-impact costs are often as much as 1.5 times the brokerage commissions. As if mutual funds were not difficult enough to understand, they come with what is called a prospectus. A prospectus is usually a long-winded document that explains in great detail the investment objectives, level of risk, costs and fees, past fund performance, fund management objectives, etc. They are written by attorneys and filled with difficult-to-understand legal jargon and largely go overlooked by the common investor.
Make sure you understand whether or not your mutual funds are back-end loaded or front-end loaded. Many mutual funds will have a load attached to the purchase (front-end) or the sale (back-end) of said fund. This load is paid to the broker dealer, which means that you immediately start in a deficit. You can find no-load funds that are usually much better options than funds that have sales loads.
Commissionable mutual funds are also separated by what is called share class. There are four main types of commissionable mutual fund classes: A, B, and C-shares as well as No-Load Funds and ETFs.
• Class A Shares - Class A shares carry lower 12b-1 fees and usually require a larger initial investment. Many A shares also have front-end loads attached to them that subtract a fee from your initial investment. The commissions usually get smaller as the investment gets larger.
• Class B Shares - B shares are classified by the back-end load that they come with. Therefore, they do not have front-end loads, meaning your entire initial investment earns interest. Their yearly expense ratio is higher than Class A shares.
• Class C Shares - C shares are classified as a level-loaded fund and are usually close in similarity. They have the highest expense ratios of all three classes, carry back-end loads, and carry no opportunity to convert to a different share class.
• No-Load Funds – These funds are sold without a commission or sales charge. The main reason they do not have a charge is because shares are distributed directly by the investment company, rather than a secondary party.
They can also have an annual account fee or custodial fee. Last, depending on whom you are working with and the size of the overall fund, a management fee may also come into play. This is the cost your broker is charging you in addition to everything else listed to “manage” your mutual fund portfolio.
VA’s are considered risk-type assets because the value of the annuity goes up and down with the value of the funds it holds. They are one of the most expensive places you can park your dollars, and brokers and bankers love to sell these fee-loaded accounts. Variable Annuities are made up of sub- accounts holding various mutual funds, stock and bond funds within them. They also carry insurance-related costs, including mortality and risk charges as well as administrative and fund expenses. In fact, variable annuities’ fees can total as much as 3.00% per year or more. Most of the time, owners of variable annuities are unaware of the total cost because common fees are located in the prospectus. They are normally purchased through a broker who does not have “Fiduciary” responsibility to the client. Most insurance agents and brokers are not required to disclose fees because they are not a “Fiduciary.”
What can you do?
Often times investors are told by their broker or advisor that they need to own riskier "stuff" because they need to hedge for inflation...or they will not have enough money to make it through retirement. Unfortunately, when people are close to retirement or already retired, they should be moving away from excessive risk and into a complete financial plan. One that develops protection for your assets while providing lifetime income that you cannot outlive.
To fully understand how much you are paying for your current portfolio, allow us to price your relationship with Morningstar and Fidelity. Without knowing exactly how much you are paying your advisor, how can you know what type of value he/she is providing?
You owe it to yourself to get a second opinion. Our proprietary Financial G.P.S. (Guided Planning System) process can help you develop total financial security. Call our office right away and take advantage of a FREE, no obligation 30-minute consultation. Toll-free, 1-866-417-4156.
William "Bill" Smith, RFC
President and Founder
W.A. Smith Financial Group
For further educational information or to attend one of Bill's workshops, please call toll-free, 1-866-417-4156. You may also email us at ContactUs@GreatLakesRetirement.com