The heavy burden of recurring investment fees (Part 2 of 2)
< < — Go to Part 1
By charging fees as a percent of your assets, the investment industry can make their recurring fees seem small – like they are “just a few” percent.
Furthermore, by charging fees against your assets the industry can still bill you every year, even if the value of your investment portfolio declines.
An alternative client billing method would be to charge a percentage of your actual investment returns. Tying investment management performance to investment returns would seem to be a compensation mechanism that would be more closely connected to serving your investment growth interests. If your investment managers improve upon your risk-adjusted portfolio performance above an appropriate passive index fund benchmark, then they might actually earn their fees. (See: The illusion of superior professional investment manager performance)
However, if investment managers were to charge against your returns and not your assets, then the percentage of your returns would have to be a huge proportion of your annual returns. In fact, to equal the fees they charge as “just a few percent” against your total asset portfolio, they would have to extract in the range of 1/3 to 2/3 of your annual portfolio returns every year. Moreover, if you did not have a return in a particular year, then the industry would not get paid – just like you did not get paid by the markets!
Of course, you do not have to worry about paying a percentage of your returns, because the Investment Advisers Act of 1940 specifically prohibits taking a percent of a client’s returns, unless the client meets certain qualifications, that is, the client is a qualified investor who is already relatively wealthy and supposedly more sophisticated. Instead, the Investment Advisers Act of 1940 allows only for charging some percentage of assets each year for investment management services. On its surface, this might at first seem like consumer protection, because investment managers cannot directly take away the investment returns of naïve investors.
The direct investment asset management fees of advisors typically are in the .75% to 1.5% (or higher) range, but these are not the only fees that individual investors pay. When individual investors pay asset management fees, they expect that the advisor will actually earn their fees by delivering better performance than they could have with a passive, very low cost index fund investment strategy that targeted a market return. (See: Can you really beat the securities markets? and Chance creates the illusion that individual investors can beat the stock market)
Therefore, advisors to retail investors rarely suggest adopting a low cost passive index fund strategy. Instead, they put their clients into actively managed mutual funds with much higher fund management expenses and higher, more costly investment turnover. Alternatively, they might frequently buy and sell ETFs and incur substantial transactions fees. Furthermore, many investors will pay additional investment sales loads for the privilege of riding this costly investment merry-go-round.
The total fees extracted through percent of assets fees and sales loads is huge. In total, the average investor ends up paying between 2% and 3% of their portfolio assets every year, and many pay even higher percentages. The average investor paying these fees is likely to end up with less than they would have had, if they had adopted a very low cost index fund investment strategy.
Starting today, you should focus on correcting any cost-inefficiencies associated with your current and future investment cost practices. You can only do something about investment costs going forward. Stop giving your assets away through excessive and unwarranted recurring investment fees and sales loads. (See: Pay less to get more)
Tags:
investment managers
Personal Financial Planning
- Avoiding Financial Advisor Frauds and Scams – Part 1 (
Part 1 of the The Never-Do List - 22 Good Ways to Avoid Financial Advisor and Investment Counselor Frauds and Scams
This article discusses things that you should “never do” with a financial planner or investment advisor, and it covers adviser selection, contracts, signatures, and ownership title of your assets.
You should never do certain things with [...])
- October 4 2007 Edition of the Carnival of Financial Planning (
Carnival of Financial Planning - October 4, 2007 Edition
Welcome to the October 4, 2007 edition of the Carnival of Financial Planning.
The Carnival of Financial Planning takes a long-term view of personal financial planning for individuals and families. We focus on efficient and sustainable personal financial planning practices that can lead to lifetime financial security. This [...])
- I Want My Treasure Back Please (
PIRATES OF THE CREDIT SEA - Part 3: I want my treasure back!! (Please)
What are my rights in the situation that I summarized in my previous article: "PIRATES OF THE CREDIT SEA: My Treasure Is Taken!"? Well, the answer is very simple. I have a contractual right to get my treasure back. I also have [...])
- How unstable have stock market returns been over time? (
Common stock equity market returns have varied widely in the past. The common stock equity risk premium has averaged about 4.1% from 1872 to 2000.
The equity risk premium is the equity market return less the risk free rate of return. The risk free rate of return includes both the inflation rate and the risk free [...])
- The Quality and Cost of Advice Paid by Investment Sales Loads – Part 2 (
Can you really get free and objective investment advice, when you pay investment sales loads? (Part 2 of 2)
Excessive investment costs and investment expenses are a plague on your lifetime personal financial planning.
Excessive investment expenses are one of the most significant barriers to lifelong family financial security. While financial services industry sales people tell you [...])
- Hitting the Citibank Stone Wall in Polite Conversation (
PIRATES OF THE CREDIT SEA - Part 4: Hitting the Citibank Stone Wall in Polite Conversation
This article continues my personal saga of trying to get Citibank to fix problems with their management of my credit card account with them.
For a summary of the overall situation, go to Part #1: My Treasure Is Taken!
For an article [...])
- Articles this Week from Personal Finance Blogs (
Best Personal Financial Planning and Personal Investment Articles this Week from Personal Finance Blogs
Carnival of Financial Planning - Edition #111 - October 16, 2009
Welcome to the October 16, 2009 Edition #111 of the Carnival of Financial Planning.
The Carnival of Financial Planning takes a long-term view of personal financial planning for individuals and families. We focus [...])
- Rational Mutual Fund and ETF Selection (
Rational selection of equity and bond mutual funds and ETFs - An Overview
Given the extremely large variety and number of available fixed income and equity investment mutual funds and ETFs, investors need a rational basis to select among them. Without scientific selection criteria and a good understanding of which factors are more or less likely [...])
- No Financial Planning Software or Calculator Can Predict the Future – Part 2 (
No financial planning software and no investment growth calculator can predict the future - Part 2
The future in not predictable, even with automated financial planning software.
< < -- Go to Part 1
The future is fundamentally not predictable. The future of personal financial planning and investing is similarly unpredictable. The Skilled Investor's approach with VeriPlan is [...])
- What are My Credit Card Contract Rights? (
PIRATES OF THE CREDIT SEA - Part 2: What are my rights?
What are my rights in the situation that I summarized in my previous article: "PIRATES OF THE CREDIT SEA: My Treasure Is Taken!"? Well, the answer is very simple. I have a contractual right to get my treasure back. I also have a right [...])
- August 9 2007 Edition of the Carnival of Financial Planning (
Carnival of Financial Planning - August 9, 2007 Edition
Welcome to the August 9, 2007 edition of the Carnival of Financial Planning.
The Carnival of Financial Planning takes a long-term view of personal financial planning for individuals and families. We focus on efficient and sustainable personal financial planning practices that can lead to lifetime financial security. This [...])
- Reduce investment expenses and control taxation – Step 7 of 10 Financial Planning Steps in the Right Direction (CLICK HERE TO READ THE SKILLED INVESTOR's OTHER ARTICLES ABOUT THESE "10 FINANCIAL PLANNING STEPS IN THE RIGHT DIRECTION
Even with optimal investment strategies, there is still substantial room to improve upon net investment performance through continued and vigilant focus on controlling investment costs and tax realization.
The fees extracted by the financial securities industry increased substantially [...])
