The following is a guest post by Kevin Cimring, CEO of Jemstep, an online investment advisor that helps people lock in more money for retirement. In this post, he talks about the costs of investing. If you would like to write an article for Money Q&A, please visit our Guest Posting Guidelines page.
It’s not too surprising that investors have lost trust in financial institutions. After all, the shenanigans that nearly brought down the entire financial system in 2008 are fresh in our minds, and many portfolios are still recovering from the damage that resulted.
To rebuild that trust, investors need transparency around investment advice. Investors need to know that the advice they’re getting is relevant and appropriate. They need to know how much brokers and advisors charge for their services. And they need to know about any conflicts-of-interest.
Unfortunately, most investors are kept in the dark, according to recent survey results.
A survey conducted on behalf of Jemstep.com by Harris Interactive set out to determine current attitudes among Americans who are investing for retirement. The survey found that 76% of people don’t understand how financial professionals are compensated, and 73% can’t identify how to find information about fees. Many people think that the structure of investment fees and expenses are confusing. That’s a bad sign. Fees matter. Every dollar you spend on fees is a dollar subtracted from your portfolio performance, and those dollars add up to a significant sum of money over time.
Professional Fees And Fund Fees
If you’re part of that majority that doesn’t understand how professionals get paid, here’s a quick primer: Brokers normally charge a commission. They earn a piece of every purchase and sale they make on behalf of your account. It can be more lucrative for a broker to invest in some products rather than others, and the result may not be in your best interests.
A Registered Investment Advisor (RIA), on the other hand, normally charges a flat fee as a percentage of the assets under his or her management. The good news is that the advisor’s incentives are in line with yours – as the value of your assets grows, so will the advisor’s compensation. The downside is that these fees can often be expensive. The typical investment adviser charges around 1% per annum of your account value, but this fee may vary and can be higher. There are, however, a growing number of investment managers who charge less than the standard 1%, so it’s worth understanding the different options available and the corresponding scope of services offered to decide which may be right for you.
You should also be familiar with the additional costs of investing that will impact your performance, such as mutual fund management fees and sales loads. Fund fees vary widely depending on whether the fund is actively or passively managed, whether it’s a no-load fund or comes with a sales charge, and whether the asset class is common or somewhat exotic and thinly traded. As a general guide, for active funds, an expense ratio greater than 1% is on the expensive side, while quality passively managed index funds are around 0.2% and shouldn’t exceed an expense ratio of around 0.3%.
The distinction here is that active funds are actively managed to try and beat the market, while index funds simply mirror the components of a market index, such as the S&P 500. When looking at fund fees, bear in mind that “expensive” certainly does not mean “better”. On the contrary, there’s a weak correlation between how well a fund performs and how much it costs to invest in that fund, based on many analyses of mutual funds, fees and performance. Whether to invest in passive or active funds is a discussion all on its own, but evidence indicates that the less expensive passive strategy may be better for the costs of investing.
Identifying Conflicts Of Interest
Are your service providers acting in your best interest? Registered Investment Advisors have a fiduciary obligation, meaning that they must act solely in their clients’ best interest. Brokers are not held to a fiduciary standard, so they may respond to other incentives that may run counter to your best interests.
Jemstep’s survey found that 56% of adults who have a retirement portfolio say that don’t think that financial professionals work solely in their clients’ best interest. The issue here is transparency. Knowing how your broker is compensated can only serve to help you make better informed decisions about your broker and the advice being given.
Interestingly, the people who best understand how financial professionals are compensated are those who manage it on their own. Thirty-six percent of people who manage their retirement accounts on their own say they’re knowledgeable about how financial advisors are compensated. Only 21% of people who have someone else manage their portfolio are knowledgeable about this.
Knowledge Is Power
The more oversight, personal involvement, and attention you give to your portfolio, the better positioned you’ll be. Taking an active role in the management of your portfolio and understanding the fees involved has become easier for everyday investors. Technology has allowed for the emergence of online investment advisors such as Jemstep.com, which provides unbiased, individualized investment guidance at an affordable and transparent price. However, if you use a professional adviser, don’t be scared to ask how he or she is compensated. Transparency is vital if you want to be in control of your financial future.
Kevin Cimring is CEO of Jemstep, an online investment advisor that helps people lock in more money for retirement. Using patented technology and proven portfolio management methodologies, Jemstep tells users exactly what to buy and sell to maximize their returns without undue risk. Jemstep’s easy-to-use website takes the complexity, difficulty, and anxiety out of investing. A Registered Investment Advisor with the SEC, Jemstep is led by a team of experts with over 100 years’ combined experience in financial management and technology innovation and development. Learn more at Jemstep.com.
Understanding the various compensation schemes and fees structures is definitely something savvy investors need to be aware of in order to make educated decisions with regards to ‘who’ – if anyone should I engage – and ‘what’ exactly will they do for me. As noted by Mr. Cimring, “The more oversight, personal involvement, and attention you give to your portfolio, the better positioned you’ll be.” Great post.
Those statistics are quite telling. Above 70% of people have no idea about how investment professionals are compensated and how this ties in with their money!
Its absolutely crucial to understand the different fees and charges and how they affect ones portfolio over time. I think it also allows one to compare different options and find ones that are cheaper while still providing greater value.
There is no way around research when it comes to personal investments, at the end of the day, you have the very best of your interests at heart, something that can’t be said of some brokers and advisers!
Kevin very nice post and a great job of pointing out some of the differences in financial advisor compensation. As a NAPFA member I am convinced (and very biased) that the fee-only model is the best for consumers. Advisor compensation (and the inherent conflicts of interest under the commission and fee-based models) is a key factor for investors to consider but beyond that they should do their best to determine if a particular advisor is right for their needs. A young couple starting out would likely be better served by an advisor who works on an hourly basis vs. someone who focuses on clients with a a minimum of $500,000 to invest. Sadly our profession doesn’t always make it easy for investors to choose the right advisor which is unfortunate.