If you’re a smart consumer, you usually ask questions before you spend your money. For example, if you’re hiring a decorator, you usually ask whether you’re paying a flat fee, hourly rate or percentage of what you buy. In the same manner, you should ask—and understand—how your financial advisor is being paid.
Here is a portion of a letter I once wrote to a prospective client. In it, I explain why some advisors who claim they’re not charging you anything may actually end up costing you quite a lot! A financial advisor should be upfront about how you are paying them for their services, so don’t be afraid to ask for the details.
After I met with Pat, she asked me to write you to explain our fee schedule. She mentioned that you two have a friend who is invested through Fidelity who “doesn’t pay anything!” She was wondering why you are paying a fee if your friend isn’t.
Since I am always honest, I feel strongly about clearing the air. Everyone knows that there is no free lunch in life. No company is going to provide services for free. Your friend is paying although he just doesn’t know how a percentage of his investment holdings are paying for the brokerage’s fees.
Let me show you the easy math of fees. A do-it-yourselfer using no-load mutual funds will typically pay 1.25% – 1.50% in fund fees and expenses each year. The investor doesn’t see this charge as a dollar amount (since the fund companies aren’t required to do so) but instead the share price is lower. You and Pat have Fidelity brokerage accounts worth about $786,000. If you apply 1.25% in fees, you would end up paying nearly $9,825 in fees every year! However, your fund fees are only about $3,930 annually the way we invest. In fact, you’re saving $5,895 each year in expenses. If you deduct the money you’re saving ($5,895) from our $10,000 yearly fee, your ‘net’ cost for our services is $4,105. I would like you to think about your fee in the following way:
- Could you recover this over the long-term if there was better investment performance compared to what you might obtain on your own?
- Will we save you this much or more in mistakes we might be able to keep you from making?
- Will you save at least the equivalent in time, energy, worry and recordkeeping?
- Some combination of the above?
Brian Fricke, CFP®
It’s worth spending some time and energy to understand the fee structure of your financial investments. Make this a priority when seeking a financial advisor to work with. For more great advice on planning for your incredible retirement, request a free copy of Brian’s book Worry Free Retirement.