Hidden Financial Advisor Fees You Don’t Know About, But Should

Personal Finance

Hidden Financial Advisor Fees You Don’t Know About, But Should

When it comes to the fees you pay your financial advisor, what you don’t know can hurt you – as small, hidden costs can take a significant toll on your investment returns over the long term.

Published on 1 November 2017

It is, without a doubt, a smart idea to get a professional to help you with your personal finances. A financial advisor will typically begin by asking you a series of questions in order to gain an understanding of your goals. You will have to estimate the sums that you will need for your retirement, your children’s education, and to meet your other responsibilities.

The financial advisor will then assist you in determining your financial requirements, devising a customised investment and savings plan, and constructing and managing an investment portfolio that will help you to achieve your goals. By engaging the services of a financial advisor, you can expect to maximise your returns while ensuring that your nest egg remains as safe as possible.

Of course, this service will come at a cost. You may be required to pay a certain percentage of your assets under management (AUM), which will be a yearly cost that will increase as your total investments grow, or else a flat, fixed fee, retainer, or hourly fee. And in addition to these fees, you may also be hit with other hidden fees and charges.

Before engaging a financial advisor, you must understand exactly how much the services they provide are going to cost you. The best way to get this information is to ask for it directly. Don’t sign on the dotted line until you are provided with a detailed, itemised breakdown of the charges that you will have to bear.

When you get this information, you should study it carefully and understand its implications. At times, it may be difficult to decipher the financial jargon that is used to explain how much you will be paying.

It is possible that certain hidden expenses could be deducted from your account. These may take the form of third-party fees, commissions, and management charges.

In fact, there are a wide variety of hidden fees that you should watch out for. Here we reveal some of the common hidden financial advisor fees and charges:

Mutual fund fees and expenses

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The amount that you invest in a mutual fund could be subject to a front-end load. This is essentially a sales charge and is used to compensate the intermediary responsible for directing business to the mutual fund.

If you allocate US$10,000 to a particular fund and a front-end load of 3% is levied, only US$9,700 will be invested on your behalf. The remaining amount could be used to compensate your financial advisor.

Your mutual fund could also impose a back-end load. As its name indicates, this charge is applicable when you liquidate your investment, and is often comes into force if you redeem your investment before a certain number of months have elapsed.

In addition to a back-end load, you could also be charged a redemption fee, a marketing fee, and a management fee. These deductions do not usually result in any benefit to your financial advisor.

However, your financial advisor may earn a trail commission from the mutual fund, which will continue to be paid if you remain invested in the fund.

Share and bond markups

Your financial advisor may not earn any commission on the stocks that are purchased on your behalf. But there is another way that the advisor may be compensated: shares may be purchased at a markup to the market price.

A part or the whole of this markup may find its way to your financial advisor. This markup – which is sometimes referred to as a “spread” – could be a hidden cost for you and a source of additional income for your advisor.

While it can be difficult for you to ascertain whether your financial advisor is earning a markup or a spread on your purchase, it is definitely worth your while to ask if this is indeed the case.

Additional costs on your bond purchases work in a similar fashion. The financial advisor would sell a fixed-income product to you, and earn a spread in the process.

Earning a markup in this fashion on the purchase of shares or bonds usually happens when the financial advisor or an associated entity acts as a principal. In this instance, the sale takes place from the advisor’s or associated entity’s own inventory and is made at a rate that is slightly more than the current market price.

Fees on your cash balance

The most common method that financial advisors use to charge their clients is to calculate their fees as a percentage of AUM.  If you invest, say, US$250,000, you will pay US$2,500 per year if the fee is fixed at 1% on AUM. This amount could be payable in advance every year or on a quarterly or half-yearly basis.

There are some common variations of this practice. Many financial advisors charge progressively lower percentages for higher investment amounts. Another alternative that is commonly employed is to charge a fixed fee for various slabs.

According to this method, you may be charged in the following manner:

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However, it is important to note that there is a hidden charge in every method that employs calculating fees as a percentage of AUM. At certain points in time, a part of your portfolio will be held in cash. An AUM-based fee structure will effectively charge you for your cash holdings as well.

You could seek a clarification on this issue when you are negotiating your fees with your financial advisor.

The cost of changing your financial advisor

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If you are not satisfied with the performance of your financial advisor, it may make sense to look at switching over to another professional who you think can do a better job.

But before you take this step, ask yourself: is the advisor’s poor performance a result of market conditions or of an inability to make the most appropriate investment decisions? If it is the former, it may be best to stick with your financial advisor.

If you move your account from your existing financial advisor, it will likely result in additional costs. Your new advisor may not agree with many of the investment decisions your previous advisor made, and may opt to dramatically alter your asset allocation. Liquidating these investments and making fresh purchases will result in a new round of costs. This is an important factor to consider before deciding to terminate your relationship with your advisor.

The bottom line

Before engaging a financial advisor, it is essential to get a complete picture of how much you will be paying your financial advisor in fees and to uncover the hidden costs that you may have to incur.

You should take the time to understand the different types of hidden fees and charges that will be levied on our account, and use this information to negotiate a better deal for yourself with your financial advisor.

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