Monday, April 20, 2009

Financial planning fees explained

On Mondays, we post questions from our readers, followed by an answer from Dan Danford. Feel free to post your own questions in our comments or @ reply to us on Twitter @family_finances.

QUESTION: I need some financial help and I understand the need to shop around. I read some articles about choosing an advisor, but I’m very confused about fees. How do you compare fees from one advisor to another? How important is that?

ANSWER: Since you asked, I’m going to share my best thinking on the subject. This will take a few minutes, but the subject requires some explanation and depth. I started Family Investment Center as an alternative to conventional fee structures, so I’ve given this subject a lot of thought.
And it is important. The investment world is extremely competitive. There is a stockbroker on almost every corner. There is a bank - with a discount broker in the lobby and a trust department upstairs - at almost every major intersection. Add in insurance agents and financial planners, and it all begins to run together with alarming sameness.
But it’s not really the same.

Some consumers focus on fees because it seems an easy (and important) thing to compare. If you are so inclined, you can visit a number of potential managers and collect their published fee schedule. You’d need to collect schedules from banks, brokers, investment advisors, financial planners, and (in some cases) insurance agents. By studying these documents, you’d probably arrive at a pyramid of fees.
This would be a great approach except for one thing. All options aren’t equal. We aren’t talking about a loaf of bread here, or two dealers offering identical cars. Instead, we are considering a field where there are thousands of products, and widely varying degrees of professional competence. We’re also working in the realm of horrendously complex cost structures amid an ocean of hidden fees.
Take that bank trust department, for instance. Fees shown on their schedule might omit profits they earn from their own family of mutual funds. It’s also likely that very small print discloses other administrative fees earned from outside mutual funds. They probably get income from clients plus income from selected investment options.

This isn’t illegal or necessarily unethical, but it helps disguise the total fees you pay. Looking at the published fee schedule, it’s unlikely that you’ll come away with a helpful understanding of total costs.
Similarly, just try to decipher the fees you’ll pay in an insurance product or brokerage account. It seems so simple, but I guarantee that you’ll go nuts trying to find a “bottom line” on these costs. Trying to compare costs within one industry is hard enough, across industries (insurance versus banking, for instance) is nearly impossible! It takes a carefully trained eye.
Second, and this is very important, all these options aren’t equal anyway. Since when does a broker equal an insurance agent equal a bank? Doesn’t quality of products or management mean anything?
Are all stockbrokers equal? Does the newest broker, fresh from a 12-week training course, offer similar value as the experienced professional in the corner office? Which offers better value, a fifteen-year insurance agent or a brand new trust officer? If you’re getting ready to invest $100,000, which should you trust more?

There’s a fair chance that the bank’s trust officer never passed a securities examination (trust departments are specifically exempted from the routine exams required of brokers, insurance professionals, and investment advisors). In fact, a discount broker in the bank’s lobby (where licenses are required) is potentially better tested than the trust investment officer! Does that affect your view of their investment advice?
None of this discussion is meant to slander good professionals working in the investment arena. However, it does reveal some difficulty in evaluating investment services, especially on the sole basis of fees.

It’s important to realize that I created Family Investment Center after spending 15 years in the trust/investment industry. I specialized in employee benefits and large IRAs, which offered unique insight into investment services and fees. You could say that I developed some expertise about industry costs and fees.
Here are some important lessons that I learned.
Commissions distort investment advice. They lead investment salespeople to recommend one option over others that might do a better job or cost less. In fact, the sales commission alone virtually assures that a product costs more than other options in the marketplace.
I often hear professionals say that they aren’t personally influenced by sales commissions. Consider this: Would brokerage firms, insurance companies, or banks (experts in generating income) use them if they didn’t work? Come on.
Similarly, “in-house” investments (banks or brokers offering their own mutual funds, for example) create a related distortion. The need for profits compels the organization to favor these over other choices. Of course, there’s also a built-in (and largely hidden) fee for consumers. Some groups offer a fee “discount” if you choose their products or funds – more illusion than reality.
Note also that in-house options rarely match performance offered through outside funds and managers. This may seem a small point, but it’s not. If a firm recommends inferior mutual funds, then they are – in essence – placing organizational profit motives above client needs.
Hidden fees are higher fees. I once reviewed a company pension plan offered through a national trade group. My client insisted that it was free. Buried deep in the fine print, dozens of pages into the plan prospectus, I found a disclosure of nine different charges taken against the account. Nine different and expensive fees!
In most of the investment business, sales skills are more important than investment skills. In a commissioned environment, survival requires sales. Products offered in this environment cater to consumer whims, not investment quality.

Admittedly, I consider investment fees from a different perspective than most consumers. That’s unavoidable since I have professional knowledge and experience in evaluating costs and fees. With the prior explanations as background, here’s why I’m glad you asked about fees:
Family Investment Center was created using a very simple concept. No hidden fees. Clients know right up front how much they’ll pay for our service. They know we provide honest evaluation, unbiased research, and friendly, local service. We scan the universe for quality managers and we don’t sell any “house” funds or investments.
In fact, we employ a variety of methods to control total investment costs. We charge fair and reasonable fees for the services we provide. In fact, total fees are actually lower than most other options in the marketplace.
We aren’t unique. There are hundreds of advisory firms nationwide operating in a “fee-only” environment. I prefer the term commission-Free because it’s a better description of what we do and how we operate. Again, there are hundreds of us.

Take away the commissions, and false expertise disappears, too. Education, skills, experience, and knowledge are where significant value is added.
The crucial point is that it takes judgment, skill, and experience to properly engage this knowledge for your benefit. Of thirty similar mutual funds, which one (or ones) is the best choice for your situation? Which one (or ones) fit best with other securities to meld a quality-diversified portfolio? Which one (or ones) offers the best tax efficiency for a family in your circumstances?
You may be able to find a cheaper alternative (or something that looks cheaper). Just like you can find a cheaper lawyer or a low-cost doctor. Truth is, every lawyer belongs to the bar association and every doctor holds a medical license. Chances are good, though, that you’ll look beyond price in choosing the right one for your situation. Cost, while a factor, isn’t the only factor.
Fees are only part of the picture. You have to consider everything else to arrive at value. Commission-free investing offers top value for most families. That’s why I love to talk about fees.

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