"I feel like a total fool. Why didn't I learn about my investments years ago? Thank you." - Sam K.
Quotes
Evaluating Your Costs
"We are accustomed to believing that the more we pay for something, the more we receive. Sorry; this is not how it works when buying mutual funds. Every dollar we pay in commissions, fees, expenses, and so on is one dollar less that we receive from our investment. For this reason, it's critical that we keep our investment costs as low as possible!" -- John Bogle, Founder of Vanguard
"The first thing to look at is the expense ratio; the second thing is the turnover rate; the third thing is some measure of past performance... But if you had to look at one thing only, I'd pick expense ratio." -- William Sharpe, 1990 Nobel Laureate in Economics
"The main reason to be wary of funds with high 12b-1 fees is enlightened self-interest. The more money you give to your fund, the less you have left over to invest." - John Waggoner, USA Today
"All things being equal, funds with high costs are much more likely to produce poor performance because of their cost disadvantage. However, all things aren't equal and most high-cost funds also have weaker management, higher risk strategies, and fewer resources. Put that all together and you have a recipe for failure. " - Russel Kinnel, Morningstar
Let's take a look at what you are paying in mutual fund fees. We'll go step by step using Morningstar, a respected site that gives information about investments. You’ll need your investment statement.
1. Take a look at your investing statement and see if you can find your fund's 'ticker'. It's usually 5 letters that represent your fund. An example of a ticker is 'VFINX'. (If you can't find a ticker, then we’ll use the fund name.)
2. Next, we’ll open a second internet session to access Morningstar, You will be bouncing between this screen and Morningstar.
Let’s go. (Opens Morningstar session.)
3. In the upper left corner on Morningstar where it says ‘Quotes’, enter your fund's ticker and click the arrow. If you couldn't find the ticker, enter the fund name. If your fund doesn't come up, enter the name of the fund company (examples: Vanguard, American, Riversource, Columbia, T Rowe Price, etc) and look through the list of funds for your fund.) Write down the ticker and click on the fund name.
Note: If you have a problem, please email me with the fund name and I will try to assist.
4. You will now see a 'snapshot' of your fund's information. But for now, we want to look at the costs. On the left side of the screen, left of the chart, look for 'Fees and Expenses' and go there.
5. Now you can see your fund's costs. (For a detailed explanation of all costs, look at the 'Data Definitions' on the lower section of the page.) In brief, a ‘load’ is a sales commission, usually taken right off the top of any money you invest. This pays your broker (financial advisor). A 12b-1 fee is called a marketing fee but is usually also used as a hidden commission. All funds have a fund management fee, but the cost of management can be very different between funds.
Let's use Vanguard's S & P 500 index fund as a comparison with your fund's costs. Take a look at the Vanguard index fund and see how your costs might differ.
6. Finally, take a look at the rest of your funds to find out what you are paying for your investments.
Good job!! You are done with the first part!!! You now know what you are paying for your fund fees and commissions.
Next, we want to find out what you're paying your 'financial advisor' for his advice. Usually, they are paid one of three ways:
Commission:
This means they sell you loaded funds...funds with commissions. The commission can come off the top - a front end load. You can see the load disclosed on the Morningstar fees and expenses page you looked at earlier. You might have been sold a 'B' or 'C' share. These funds don't charge a front-end load, but they do charge an ongoing commission in the form of a higher 12b-1 fee.
Let's look at an example of the same fund with different share classes:
Class A - Front end load (note the 12b-1 fee):
Class B - Deferred load (note 12b-1 fee) that is higher but reverts to A share costs after a few years
Class C - Deferred load (note 12b-1 fee) that is higher and stays high
In addition to these commissions, your financial advisor may also charge you a planning fee and may receive other forms of payment.
Note: If you invest a large sum of money in a loaded fund, you should pay a reduced load - this is called a breakpoint.
Fee based:
This usually means that your financial advisor charges you a percent of your assets every year. Let's assume you have $500,000 invested and your wrap fee is 1.5%. You will pay $7,500 that year to your advisor. That's $625 a month. Remember that in addition to the wrap fee you will pay fund expenses, but not the load. A fee based advisor may also take commissions, just not in the form of a load.
Fee only:
A fee only planner does not take commissions. They may charge a percent of your assets, or a flat (one time) fee, or an hourly fee.
Ask your financial advisor to provide, in writing, exactly how he is paid and how much he receives. Do not be afraid to do this. It is your money, your financial future and if he has a problem giving you this information in writing, you have a serious problem. Do not let him make you feel guilty. Do not let him intimidate you. If this is hard for you to do, ask in an email.
Now you can add up all your investment costs….Now you know what you are paying for your investments.
Important notes:
Index funds are passively managed (meaning that they follow a formula and do not try to guess which stocks will beat the market) and are usually much cheaper to own than actively managed funds. Consider: Over the past five years, the S&P 500 has outperformed 72.2% of large-cap funds, the S&P MidCap 400 has beaten 77.4% of mid-cap funds, and the S&P SmallCap 600 has outpaced 77.7% of small-cap funds. Since no one knows what funds will beat the market in the future, doesn't it make sense to stack the odds in your favor and hold index funds?
Wrap fees (percent of assets) continue for year after year after year - even if your advisor does a bad job. Even if you lose money. And, I have never been able to find out what a financial advisor does to earn this money ongoing. He sets up your portfolio, etc, the first year, but what happens after that, ongoing, that takes up as much time as the first year?
