Keep Your Investment Fees Low

Ask a pro for investing help and you can expect to pay for it. Sounds simple enough, but practices have changed over the years.

Decades ago, almost all trading was done through full-service stock brokers. Then mutual fund companies began providing advisers, often for free, while a new class of discount brokers offered to conduct transactions for do-it-yourselfers for cut-rate commissions, but without giving any advice.

The trend in recent years is what's called “asset-based” fees where the adviser charges an annual fee, typically 1% to 2% of the value of the account, to pay for investment advice and trading costs. This solves some conflict of interests imbedded in the old commission system, but it creates others.

As The Wall Street Journal noted in a recent story, annual fees reduce or eliminate the adviser’s incentive to recommend investments simply because they provide bigger commissions. Annual fees also reduce the incentive to “churn” an account, or make frequent trades to rack up more commissions.

And annual fees are easier for the customer to see and tally than older systems that used a hodgepodge of commissions, “loads” and other charges. As a result, the Journal points out, advisers are more willing to offer customers a wider range of funds and other investments.

But investors should be aware of one major drawback to asset-based fees — you could pay more than you really should.

Imagine a customer with $500,000 in an account, paying 1% a year, or $5,000. Over 10 years, the customer would pay $50,000, or considerably more if the account grew.

That’s OK if the adviser steers the client to investments that grow fast enough to offset the fees. Put another way, if the investor could select a set of mutual funds that returned 8% a year, the adviser would have to select a set doing better than 9% a year.

But it’s hard for advisers to beat average market returns year after year. If advisers don't think they can, they may find it makes business sense to put your holdings on autopilot, with a basic set of mutual funds, and then spend time increasing the assets under management by prospecting for new clients.