How Much Are You Really Paying In Fees To Your Financial Advisor?


How Much Are You Really Paying In Fees To Your Financial Advisor?

The seemingly minor sums that you pay as fees to your financial advisor can have a major impact on your investment portfolio’s returns over the long haul.

Published on 25 September 2017

Every investor knows that financial advice comes at a certain cost. After all, you are paying qualified professionals who have years of experience in deploying funds for their clients. Investors justify the fees and charges that they have to bear by reasoning that these will be made up many times over by the increased returns that their investments earn.

At least that is what your financial advisor would like you to think. But you could have a nagging doubt about the amount that you are actually paying in fees. When you are putting hundreds of thousands of dollars of your money into the hands of a financial advisor, it is quite natural that you would want to ensure:

  • Your money will be safe and that it will earn a reasonably high return.
  • You are informed about how much of your investment is being lost to fees and the impact that this will have on your returns.

Unfortunately, the information that you receive from your financial advisor may not give you a complete picture of the amount you are really paying in fees, and the impact of these fees on your returns over the long haul.

How fees can eat up your returns

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It can be difficult to estimate the effect that your financial advisor’s charges can have on the growth of your investment portfolio. A yearly fee that is equal to 1% of your assets may seem like a fair amount to pay, as you would reason that the remaining 99% would be invested in a manner that will ensure a healthy return.

But the calculation is not quite that simple. A 1% annual charge does not merely translate into a 1% reduction in your return.

Consider an example where you invest, say, US$300,000 for a period of 10 years. Let us assume that your financial advisor is able to earn a return of 8% per year and that you are required to bear a 1% fee every year on your assets under management (AUM). In 10 years, your original investment of US$300,000 would have grown to US$586,000.

What is the impact that the 1% yearly fee would have had on your return over a decade? It would have reduced your return by a whopping US$61,000.

If you consider a longer time frame, the impact is even greater:

Let us see the effect on your returns with exactly the same parameters as described above except that the yearly fees are hiked to 2% from 1%:

It is quite apparent that fees and expenses can have a major impact on your portfolio, and can put a significant dent in your returns.

Do you know exactly how much you are paying?

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Your financial advisor may be charging you fees that are based on a percentage of your AUM. The more assets you have under management, the lower the percentage they usually charge in fees. A fee of around 1% per annum is considered to be normal in the wealth management industry.

But you could be actually paying much more than that. If your money is deployed in mutual funds, for example, the mutual fund company could charge several types of fees. A sales charge or “load” is common. This is essentially a sales commission that is paid to the intermediary who is promoting the fund. Your financial advisor could be collecting some commission from the mutual fund company for investing your money into their fund.

“Trailer fees” from mutual funds could be another source of income for your financial advisor. These are paid on a yearly basis as long as the investor continues to hold units in the fund. The rationale behind the mutual fund company paying this fee is to ensure that the financial advisor continues to provide service to the purchaser of the fund. These fees could range from 0.25% to 1% every year. Trailer fees form part of the fund’s management expenses. Consequently, they dilute your return.

The mutual fund company typically has other expenses as well, and as an investor, you will have to pay your share of the fund’s operating expenses, including its legal fees, custodial fees, and other administrative costs. Of course, these are not charged separately, but will lead to a reduction in your overall return.

Questions to ask your financial advisor

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Ideally, all the compensation that your financial advisor earns should come directly from you. This will ensure that there is no conflict of interest. But the market practice is quite different. It is likely that your advisor will be getting a commission from the mutual fund companies that receive your investments.

It is a good idea to ask your financial advisor about their earnings that are generated from other sources. This will help you to understand the extent to which your returns are getting reduced. You could also use this information to negotiate better terms for yourself.

You may want to ask your financial advisor if you can pay a fixed yearly fee instead of a percentage of your AUM. If most of your money is being invested in exchange-traded funds (ETFs) and mutual funds, there is a greater likelihood of your advisor agreeing to this type of fee structure – and this could lead to substantial savings.

The bottom line

Don’t underestimate the benefits that you can get from sound financial advice. An experienced financial advisor with a good track record can help you build a diversified portfolio that earns a steady return. Your advisor will also ensure that you avoid making rash decisions that could have a detrimental impact on your investments and financial future.

No doubt, a skilful financial advisor’s recommendations and guidance can prove to be of great value, but you should not be overpaying for the advice that you receive.

Remember that the extra amount that your financial advisor earns in fees is ultimately going out of your pocket. The seemingly minor sums that you pay as fees and charges can have a disproportionately large impact on your returns over the years. It is well worth your time and effort to find out exactly what you are paying in fees to your financial advisor, and to try to reduce that amount as much as possible.