How to tell if the money you have is real
The cost of an account is important to one’s investment returns.
Morningstar reports year after year that the best performing mutual funds are the lowest-cost funds. Yet, for most investors, these costs (fees) are elusive. They are difficult to dig out. With only a little effort by the investor, he or she can determine those costs.
If you are working with an advisor, they should be able — and you should require it — to tell you your account expense not just in percentages, but also in dollar amounts.
Here are some expenses associated with an account.
▪ The management fee is the fee charged by the advisor for managing the account. These fees have continued to drop over the years.
I would suggest that most management fees charged today are at 1 percent or lower, and often are charged monthly or quarterly.
Recently I reviewed an account where the management fee was 2 percent. It was for a conservative client with more bond funds in the account. With bond yields as low as they have been for many years, this 2 percent fee took much of the gain away.
I advised the client to negotiate a lower fee or look for a new advisor. Lowering this fee would put more money into the client’s pocket. On an account of $500,000, cutting that 2 percent fee in half would put an additional $5,000 — or a little over $400 per month — into the client’s pocket. Doesn’t that make better sense than needlessly giving that money to someone else? I think so.
Management fees should show up on the investors’ statement under “expenses.” This is a relatively easy expense to see.
▪ Next is the “asset” fee. This fee does not show up under expenses on a statement. These fees can range from zero for individual stocks and bonds to several percentage points for mutual funds and other packaged products.
It takes a little effort to determine this cost but it is important to find it as this is often where high cost are hidden. Morningstar is an easy way to determine the asset cost for an entire portfolio as it produces that report automatically.
Some advisors, myself included, now have Morningstar integrated into our workstations so we can easily determine the asset cost.
For an individual fund, enter the symbol (should be on your statement) into any of the free online sites — such as Yahoo Finance — and you will see the asset cost as a percentage. Again, it’s important to look at not only the percentage, but also the dollar cost of that fee.
Using that same example above, we found that the asset expense was 1.25 percent. Moving to a lower cost asset fee of 0.75 percent (typically we can lower this fee much more than to 0.75 percent with exchange traded funds), we have saved the investor another $2,500 per year — or a little over $200 each month.
▪ The final expense is the transaction expense. This is the buying and selling cost of one’s investments.
A lot third-party management programs have rapid and much more than necessary transactions, which drive up your cost; taxes as well if in a taxable account. This expense should also show up on your statement under “Expenses.”
The transaction expense that is hidden is the expense once again associated with mutual funds called the turnover percentage. It is almost impossible to determine this exact amount since it is not on the basic prospectus.
But, using the turnover ratio can give us some idea. The larger the turnover ratio, the more expense.
Again, using the same example above the turnover percentage of a bond mutual fund in the account was 45 percent. While not precise, I use that percentage turnover as an expense. In this case it would be 0.45 percent for the expense.
It is easy to buy good individual bonds or bond ETFs that have zero turnover expense for individual bonds or low turnover ETFs. Using the same dollar invested as above, we could reduce the turnover fee to 0.05 percent, saving the investor $2,000 per year — or another $160 per month.
These are your total expenses associated with most accounts. You should know your total percentage cost as well as in dollar terms. Your advisor should show you all the costs associated with your account. If he or she is hesitant, find another advisor who will.
We have helped put an additional $9,500 annually — or $790 a month — into the client’s pocket. That’s exciting.