Many investors fail to ask the BEST question to get the TRUE cost of working with a financial advisor. By J Thomas Knight, CFP®, CPA
Money, income, savings, portfolio, retirement, estate, legacy; it’s so important that there are multiple ways to say the word…security. Not just important but vital. So essential and vital that it should not be a Do-It-Yourself (DIY) project; kind of like how brain surgery should not be a DIY project either.
Fortunately, smart investors recognize this and hire a professional to help save, grow, protect, and distribute their wealth. Advisors, when addressing the issue of investing, can design a suitable portfolio to achieve your financial objectives with higher returns and less risk than you could on your own.
Brain surgery ain’t cheap. So what does it cost to hire an advisor? Notice, we didn’t ask, “What is the price of an advisor?” There is a small distinction but a big difference between Price and Cost.
To clarify that distinction, let’s define Price and Cost.
Price: The original amount you initially pay to obtain a product or service.
Cost: The total amount needed to initially purchase the product or service PLUS the additional funds required to maintain the product or to pay for ancillary but necessary services.
Maybe an example is best. Let’s say the price of your dream car is X dollars (taxes, tags, and title included). X dollars is what it takes to drive it off the lot, but that’s not what it costs you, because then come the added and ongoing costs of interest (if you financed it), insurance, gasoline, maintenance (oil changes & tune ups), and the replacement of wearable items like tires and windshield wipers. The cost is much too complicated to provide a precise answer to the question of, “What did your car cost?” Therefore, when asked, we reply with the price we paid for the vehicle rather than its true or total cost.
Investors are smart enough to know to ask, but unfortunately, they often ask for the price of the advisor rather than the cost of working with him or her. Questions like, “What do you charge?” or “What is your fee?” is just another way of asking what the price is or what their compensation is.
The BEST question is…
“What are the total costs involved, that I will incur, if I were to hire you as my advisor?”
A majority of advisors create portfolios using mutual funds or exchange traded funds. As a result, you’ve now not only hired an advisor to select the funds, but hired the mutual fund manager as well. And the mutual fund manager charges a fee plus has trading costs. THREE costs from one fee. What can be said? – It’s new math. Full disclosure from the advisor would be helpful, but technically you already have all this information. Why? Because each fund in a portfolio comes with a prospectus which you can and should have received, you know – that thick batch of onion paper which no investor has ever read. Inside the prospectus is the expense ratio which shows how much the fund manager charges. What may or may not be in the prospectus are the trading costs. If provided, the trading costs or transaction fees would most likely be in the additional information section of the prospectus.
These THREE items, Advisor Fee, Expense Ratio, and Trading/Transaction Costs, add up to be the TRUE COST to work with an advisor. Rather than hunting and pecking for this information, just ask the advisor for it and have them show you their fees plus the fund expenses from within the prospectus.
Examine the chart below. You’ll see how an investor could easily incur a total annual cost of well over 3%. Be very specific when asking an advisor what they charge. If they reply, “My fee is X%,” they may be leaving out the expense ratio and transaction costs that will add to their initial “price”. Make sure they tell you the TOTAL costs you will incur if you were to hire them as your advisor.
BOTTOM LINE: Anytime an advisor recommends any investment, such as mutual funds, ETFs (exchange traded funds), individual stocks and/or bonds, private money management, or a separately managed account containing any type of security, you must be careful and should request a presentation of the TOTAL COSTS of such arrangements which can include their management fees, plus 12b-1 fees, brokerage commissions, trading expenses, administrative fees, and other fees.
“Are you a Fiduciary?”, “Are you a CFP®?”, “Are you Commission-Based, Fee-Only, or Fee-Based?” are more BEST questions to cover with prospective advisors, but we’ll save those for another time.
- Based on data provided by Rydex Advisor Benchmarking Research Study (Over 300 advisory firms were surveyed in the 2011 study).
- Based on 831 Large Capitalization Growth mutual funds and ETFs tracked by Morningstar Screener (as of 7/31/2012).
- Based on PersonalFund.com’s Mutual Fund Cost Calculator (as of 8/18/2012). Investment companies generally do not publicize their internal trading costs and the best anyone can do is to make reasonable estimates based on statistical studies.
- DEFEND & Deploy® is an investment strategy, administered by Winston Paul Capital Management, which contains a fee schedule with a maximum fee of 1.95% of assets under management (as of 12/18/2017). All expenses and trading costs associated with the DEFEND & Deploy®, while utilizing individual stocks and/or bonds, may not be included in or covered by the management fee. However, DEFEND & Deploy® has the flexibility to utilize mutual funds and/or exchange traded funds in addition to or in lieu of individual stocks and/or bonds; thus, the listed average annual expense ratio and estimated trading costs could increase. For more DEFEND & Deploy® program information, refer to the Winston Paul Capital Management brochure.
IMPORTANT: This chart is for illustrative purposes only and does not represent the actual fees and/or expenses of any specific retail mutual fund, ETF, or DEFEND & Deploy® investment strategy. The actual DEFEND & Deploy® fees and/or expenses associated with a given investor and/or investment may be different. All information is based on historical data; thus, it could vary. This chart and all accompanying text refer to advisors who recommend mutual funds and/or exchange traded funds to their clients.
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