Several years ago I wrote a paper on the various costs of investing, how controllable they are for investors and how important this issue is to your long term wealth. While I encourage you to read the paper in its entirety (click here for the paper), let me give you a few of the highlights and then move on to a few additional observations.
Investment costs generally fall into four categories: advisory fees, expense ratios, trading costs/commissions, and taxes. The first two categories can eat up 2-3% of your portfolio annually, trading costs can shave another 0.5-1% (or more, by some accounts), and the tax you pay is its own beast specific to your individual situation and requiring separate attention. Conservatively speaking, I’d say most investors easily pay 2.5-3.5% of their total portfolio in fees/costs each and every year before taxes. Most importantly, however, these costs can and should be under 1% total for every investor and we demonstrate how easy it is at Frontier Advisors, where we are able to reduce these costs by over 70%. Every dollar not taken is a dollar saved to be spent elsewhere or, even better, kept in one’s portfolio to grow and compound over time, resulting in immensely more wealth over the years. For more on keeping a financially healthy business, read here the latest post with some of the best Business energy saving tips .
While I think the paper stands on its own as a comprehensive explanation of the costs investors bear, I’d like to make three additional points. First is a bit of good news in that the pressure for costs to come down has been increasing. The fiduciary rule that went into effect in June has brought much needed attention to this issue that won’t subside just because they revoke the rule. Also, competition for investment dollars between active and passive and then within the active and passive philosophies themselves is creating pricing pressure. Prices haven’t dropped as much as they should have in the active space given their abysmal performance, but in the passive world costs have come down considerably over the last several years. At Frontier, the expense ratios of the passive tools we use in our portfolios have dropped by about a third since 2009! In addition to expense ratios, trading costs are also decreasing. Our clients pay around half of what they use to for equity trades! I can’t speak to how trading costs may have changed at full service brokerages (my guess is that they are all still ridiculously expensive), but in the discount brokerage world, already nominal trading fees have gone way down.
Second, fee transparency is increasing. The Department of Labor has added transparency requirements within the 401k world and all retirement assets should become more transparent if the fiduciary standard that took effect in June stays in place. It’s important to remember, however, that the these transparency improvements only apply to retirement accounts (IRAs, 401ks, etc.) and NOT taxable accounts. The SEC has yet to act at all in this regard, so most investment assets are as they were, but investors are at least becoming aware that something’s amiss in the investment world.
This leads me to my third and most important point. Investors are woefully unaware of how much they pay and the industry continues to do all it can to make sure investors remain ignorant. A 2017 survey by consulting firm Cerulli Associates found that about half of investors don’t know what they pay and half of those thought they didn’t pay anything at all. I’ve encountered many advisors who can’t accurately explain the fees their clients pay and many who simply have no idea. I have yet to encounter an advisor who thinks they or their firm should make less than they currently do!
For those investors who truly want to figure out what they pay, it’s incredibly difficult due to the lack of disclosure, the overall ignorance within the industry (can’t get a convincing answer to questions), the complexity of fee arrangements, and the lack of true honesty among many investment professionals who have a strong incentive to keep comprehensive cost information hidden. There was a very eye-opening article recently in The Wall Street Journal by an investigative reporter who had an incredibly frustrating time trying to figure out what her own investment accounts cost her. In the end, she couldn’t get a written answer indicating her actual fees (“What’s My Investing Fee? A Frustrating Quest,” by Andrea Fuller, The Wall Street Journal, May 17, 2017).
And without a fiduciary rule requiring advisors to keep the best interests of clients in mind, ridiculously expensive products will continue to proliferate the market. Examples are loaded mutual funds that take 4-6% off the top when purchased, private real estate investment trusts with their average 13% up-front fee, hedge funds with their 2% fee and 20% of profits structures, and variable annuities with their contingent deferred sales charges and loads of hidden fees within the products.
So consider yourself forewarned in case you didn’t already know that a huge problem exists around this issue. And while there is pressure to reduce fees to some degree, I’m also seeing a growing movement to broaden service offerings to justify higher advisory fees or at least keep them from coming down. So when you are presented with a long list of all the things a firm will do for you all for their li’l ‘ole 1% fee, know that most of it is bunk. They are charging you an ongoing fee for one-time services that ought to be part of what they do anyway (planning discussions, review meetings) or actually fall to other, more appropriate professionals (tax and estate advising that should be done by CPAs and attorneys). Instead, flip the question on them and ask them to justify in dollar terms the total cost of your investment portfolio and each and every service they think you’ll need. That exercise should be enlightening for both sides.