I believe that everyone, no matter how much investment experience they have, should learn how to take control of their investing, buy a well diversified portfolio of index funds, periodically rebalance their portfolio, and allow their money to compound without fees. So do Warren Buffett (read what he wrote about fees), John Bogle, David Swensen, and other investment industry luminaries. This is because the fees charged by the financial industry, over time, decimate investment returns.But many people just want investment advice. Most people will spend more time shopping for a car on the weekend to save $1000, than to understand the true cost of the investment advice they are receiving on the nest egg that they're spending their entire working lives building. If you must, here are some tips that I think will help you minimize the damage and give you a shot at having a successful relationship with your stock broker, financial adviser or investment manager.
1. Show Me The Fees. If your financial adviser is charging a fee to oversee your investments, he is probably investing your money in mutual funds that also have fees. Ask for a comprehensive list of all the fees you are paying each year including each fund, its fees, and his fees. Try to get these aggregate fees below 2% per year. My friend has a $6 million account with one of the largest four brokers and to make my point, I calculated his mutual fund fees, loads, and fees to his advisor. Last year he paid about $138,000! He is considering switching to index funds and where he would pay $18,000 per year.
2. Get Invoiced. Most financial advisors "debit" your account either in advance of the quarter or month. Ask them to send you an invoice and write them a check. That way you'll stay aware of the cost for these services.
3. Show Me The Commissions. Ask your adviser to disclose the exact amount of commissions, credits or any form of compensation he or she is paid as an incentive for having you invest in a certain financial product like a mutual fund, annuity, or life insurance product. Also ask for the cost of an index fund alternative so that you can understand exactly what it is costing you to be "sold" a particular product and so that you can justify its price in the future.
4. What's The Tax? The average turnover for a mutual fund is 70% a year. That means nearly all stocks in a portfolio are sold each year and traded for other stocks. Turnover can create taxable income at year end. Each February, after these taxes are known, give your financial advisor your federal and state tax rates and ask him to calculate the taxes generated turnover from your funds. Then sell down these accounts in the amount you need to pay the taxes so you will be able to know the true after tax returns. After all, that's what you keep.
5. Benchmarking -- Compared to What? Many investors are happy when they make money in a fund. But that's how amateurs think. Endowments and elite institutions manage their money managers against a benchmark who, net of fees, should outperform a comparable index fund which charges almost no fees. Have your financial advisor pick a benchmark for each fund and measure your adviser's fund picking skills against how well that fund did against the benchmark. For example, the largest diversified emerging market funds have been up between 25.3% - 35.06% over the last five years. Vanguard's Emerging Markets Stock Index (VEIEX) was up 29.24% including fees of .35%. So if you are happy that you've compounded for 5 years at 25.3% with American Funds New World (NEWFX), you shouldn't be because you lost 4% paying someone trying to beat the market including the 1% you paid in fees.
If your stock broker fashions himself as a stock picker, ask him for a benchmark by which to judge his performance. For example, if he or she is picking large cap US stocks, then buy a token amount of the S&P 500 Index Fund (NYSE:SPY) in the account and measure his yearly returns against the yearly returns of this index.
If the requests I'm suggesting that you make of your adviser or stock broker make you uncomfortable, that's no reason not to make them anyway. These are reasonable ways to hold your advisers accountable. Just think of the discomfort you'll feel if in 15 years, a good chunk of your retirement nest egg has been siphoned away in fees!
Mitch Tuchman is founder of MarketRiders where investors use free software to invest without brokers and advisers and their expensive fees -- in just a few hours a year.
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Reader Comments (Page 1 of 1)
8-04-2008 @ 5:07PM
j99benz said...
Mitch- my advisor says the only fees I pay are the app. 1% mgmt fee to him. He says there are no fees for the funds. Is that possible?
8-05-2008 @ 12:35AM
Mitch Tuchman said...
Now that's hard to believe. Does he have you in mutual funds or is he picking stocks himself? If he has you in mutual funds, ask him to put that in writing...
8-05-2008 @ 6:08AM
Kelly said...
Mitch,
That was a cheap shot against American Funds New World Fund. New World fund is litered with multinational companies doing business in the third world and does not represent the index. It is designed to invest in the third world more conservatively than the index. As of close of business your highly touted Vanguard Fund was down 11.68% YTD while New World Fund was down 7.08%. Maybe you just forgot to mention that.
ccstheday@aol.com
8-05-2008 @ 9:28AM
Mitch Tuchman said...
Kelly:
I have no axe to grind against American Funds. Its categorized as a Diversified Emerging Markets fund and financial advisers buy it for clients to get exposure to that asset class. The fund has fees, loads and marketing expenses and over 5 years -- not 6 months -- it has underperformed the index it purports to beat. If you have a portfolio full of mutual funds with fees, some will beat and some will underperform their benchmarks in a given year. But one thing that's proven over and over again -- eventually the fees will eat you alive.
8-05-2008 @ 12:55PM
Kelly said...
Mitch,
I agree that fees are important. The expense ratio of a mutual fund is an important factor in buying funds. However the catagories have been crafted by companies like Lipper or Morningstar. That is not the concern of the mutual fund companies. They are trying to produce value to the investor. Thank goodness not all companies are index clones. Maybe I prefer to own a fund that invests in emerging markets but takes less risk than the index. That is the purpose of looking at the beta. So if you want to own an emerging market fund that takes less risk than the index then you actually have to have someone manage it. In the down years of 2000-2002 New World Fund lost over 8% less than the Vanguard Fund. Some people are willing to earn less in the good years to lose less in the bad years. The index tells only part of the story.