I love dogs. I love my dog. She’s a three-year-old Bernese Mountain Dog named Ada and you would love her, too. She’s very large, she smiles, she’s a great listener, she trundles on her morning walks, she snores, and she’ll do any of her three tricks for a treat and a head scratch. Her favorite thing to do after taking a nap is to immediately take another one.
But what I love most is how protective she is of her family. She’s on her guard in the house and will let out a deep operatic chirp if she hears a car pulling into the driveway or if a stranger approaches the front door. Canine intuition is amazing.
A few weeks ago, the Wizard of Oz was on TV. Ada sat in front of the TV, mesmerized, and noticeably reacted whenever Toto was on the screen.
Towards the end of the movie, there’s the famous scene where the great and powerful Oz is found hiding behind a large curtain. He is suddenly revealed as nothing more than an ordinary man pushing buttons to generate fire, flames, and smoke as he shouts into a loud microphone. And just as Ada speaks up when something seems suspect in the house, Dorothy’s dog sensed something strange, as well.
Toto runs up to the curtain, bites the bottom corner and pulls it open where we hear the man in a panic shout the famous line, “Pay no attention to the man behind the curtain!” Dorothy and the other misfits can now see the dozens of buttons, dials, and levers that are making this fraudulent wizard’s half-time show possible.
And since most dogs aren’t capable of sniffing out a lack of transparency, this got me thinking I would want a curtain feature on every service I pay for, including and especially my investment and retirement accounts. Because the truth is, it’s highly unlikely that your investment or retirement account statements have the curtain pulled all the way open, showing every cost that is quietly eroding your growth.
It’s very likely you’re only seeing part of what you’re being charged and since partial disclosure masquerading as full disclosure is unethical at best and quite harmful, you should know what you’re paying for.
Untangling the Confusion
When we first meet with our clients, one of the many stops on the train line is we’ll run a full analysis of your portfolio. We do a deep dive to determine and assign risk numbers to each individual holding, as well as fully expose every flavor of fee, cost, charge, rate, and expense you’re being charged.
Often, clients come in confidently saying they’re only paying 1% or 50 basis points (0.50%). They’re led to believe this number is accurate for good reason: because their statement says so! However, after doing a fee analysis on their portfolio, we’ll often uncover invisible costs such as transaction fees or expense ratios. You’ll find where and how these function on page 142 in the prospectus, often in the fine print.
But what exactly is an “expense ratio” or “sales load” or “wrap fee” and what do they mean? In the world of creative writing or art or music, synonyms and interchangeable words or phrases are useful tools to express just about anything. In the world of finance, its verbiage does not translate well and almost always creates more confusion.
We want to untangle that confusion as much as possible.
What’s Really Behind the Curtain
There are many different types of fees inside investment and retirement accounts, each unique to their respective investment vehicles. There are too many that we won’t be able to unpack all of them here. So, for now, let’s examine some of the most common types so as to sufficiently equip you better next time you speak with your broker or advisor.
A good rule of thumb: if you don’t know what you’re paying, you’re paying too much.
At root, expense ratios cover the cost of operating a mutual fund, index funds and ETFs (exchange traded funds). They’re shown as a percentage of your investment and charged as an annual fee.
If you have a fund that has an expense ratio of 0.10%, that means you pay $1 per year for every $1,000 invested.
Generally, expense ratios aren’t easy to find – if not excluded altogether from your investment statement – and are buried in the middle of a fund’s prospectus. Often, investors do not even realize it’s a fee at all. We’ve seen mutual funds with expense ratios of more than 3.2% that also lost money!
Some mutual funds carry 12b-1 fees, and they’re lumped in as part of their expense ratio. Simply put, the 12b-1 fee is considered a marketing fee to promote the mutual fund and compensate brokers, advisors or registered representatives for selling or recommending the fund.
Also, it’s wise to note that these fees can sometimes be used in a 401(k) plan to cover some of the plan’s administrative costs or to compensate the plan’s outside advisor.
A wrap fee is a comprehensive fee charged by an investment advisor to a client for providing a bundle of services such as investment advice, investment research, and brokerage services. These fees allow the advisor to charge one straightforward fee, simplifying the process. However, these can be expensive and can range from 0.75% all the way up to 3%!
Paying a wrap fee can be advantageous for investors intending to utilize their advisor’s full line of services. For others, it might be cheaper to pay an investment professional for individual services in an unbundled agreement.
Surrender fees mostly apply to some annuities and mutual funds and occur on the back end when the investment is either liquidated or sold within its surrender period.
If you’ve purchased a fixed indexed annuity with a 10-year surrender charge period and decide to liquidate or transfer it before you pass the 10th year, you can expect to be charged with a fee.
We’ve only slightly pulled back the curtain by discussing the above-mentioned fees. There are endless combinations to explore, but what’s important is which fees apply to you and your portfolio, as well as which fees are being shown and which are hidden.
At Oakmont, we aim to create and foster transparent and honest professional relationships of a sort that scarcely exist in this industry. And what our clients value with us is our effort to get at the truth.
We’d be happy to pull the curtain all the way open on your retirement and expose all the hidden fees, tax inefficiencies, and opportunities to better your future.
-Written by Michael Hicks, Associate at Oakmont Advisory Group