Understanding Investment Expenses and the Different Kinds of Financial Services

When it comes to hiring a financial advisor, what are you really paying for? What kinds of financial services are you getting for your dollar? What expenses can you eliminate? How do you find out about any hidden expenses?

Unfortunately, investment expenses aren’t simple. They are very rarely fully disclosed and can be difficult to understand. There are several different kinds of financial services and providers, and therefore, just as many layers of expenses and fees. Understanding it all can be complex, but it’s important for many reasons.

  • Expenses reduce your net performance.
  • Every dollar of expense is one less dollar you have for your future use.
  • Excessive expense undermines the achievement of your goals.

Financial salespeople know that excessive expenses will cause an investor to reject their sales recommendations. They also know that higher expenses can increase their compensation. So, many “advisors” choose to withhold expense information and hope investors don’t ask the right questions. Even when investors do ask the right questions, many salespeople will provide verbal responses so there is no written record. Remember to get all your answers about fees and expenses in writing!

What to Ask

How do you protect your financial interests from excessive investment expenses? You have to know what to ask. You should always require documented responses and avoid verbal information that is easy to manipulate or deny later. When it comes to financial expenses, trust what you see, not what you hear, and retain documentation in case there is a future dispute.

Here are 5 questions you should ask when looking for the best financial advisor to hire:

  1. Is this a one-time expense?
  2. What is the first-year expense?
  3. What is the subsequent-year expense?
  4. Who receives all or part of the expense?
  5. What kinds of financial services do I receive for the expense?

The answers to these questions will help you understand what is being deducted from your accounts, when they are being taken and why you are paying the fees.

Expenses

The number of fees, commissions and other charges that are deducted from your accounts may shock you. All of the following fees should be documented by your advisor:

  • Planning fees
  • Investment advisory fees
  • Money management fees
  • Custodian fees
  • Commissions
  • Marketing fees
  • Transaction charges
  • Insurance fees
  • Administrative fees 
  • Penalties for early withdrawal
  • Any other expense that is deducted or can be deducted from your account

Myths

Here are some common statements a salesperson may use, and the truth behind what it really means:

When an “advisor” says, “I don’t have access to expense data,” that’s not the truth. An advisor should always have access to that information if they are recommending a product to you.

What you should do: Find a higher-quality advisor who does not use deceptive sales tactics and is willing to fully disclose investment expenses.

When an “advisor” says, “This product will not cost you anything,” that is a red flag. Why would someone be providing you any kind of financial services for free?

What you should do: Make sure you require information about any type of commission that will be deducted from your accounts or paid by product companies to your advisor, including:

  • Front-end load: The amount of money that is deducted from your assets to pay a commission to your advisor
  • Back-end load: The amount of incentive compensation that is paid to your advisor by a product company, such as a mutual fund family (companies charge higher fees and penalties for early withdrawal to recover commissions that are paid to your advisor) 
  • Level loads: A recurring commission that is deducted from your assets on a monthly basis

When an “advisor” says, “I don’t charge for transactions,” these expenses are usually being replaced with fixed fees. However, the fee is still tied to transactions – the purchase and sale of investments.

What you should do: Make sure your advisor discloses all transaction charges that will be deducted from your accounts.

When an “advisor” says, “My services are free,” again, this should be another red flag. Salespeople do not like to bill you direct, because you may not pay them. Instead, many prefer to bill your accounts so they do not have to collect from you. Although rare, your advisor should describe any fees for financial advice or services that will be billed direct to you. For example, a retirement planning fee.

What you should do: Revisit the five questions above and make sure you get the answers in writing.

When an “advisor” says, “Penalties do not matter, because this is a long-term investment,” do not believe it. Penalties do matter. You could have a lot of reasons for selling the product, starting with the fact that it may have been a bad investment. Penalties have the impact of reducing your liquidity.

What you should do: Ask for more information about the product.

Penalties for Withdrawal

Your advisor should disclose any financial penalties that you will incur if you decide to sell an investment before a certain time. The most frequently used penalty period is 7 and 7 – if you sell the investment the first year, you pay a 7 percent penalty; if you sell it the second year, you pay a 6 percent penalty, and so on until it expires after seven years.

Be aware, penalties go by a number of different names, such as contingent deferred sales charges, penalty for early withdrawal and surrender charges. However, what they all mean is that a company can withdraw the penalty from your account without your approval in advance.

Tax Deferred Accounts

Make sure to ask for full disclosure for all expenses that are deducted from your tax-deferred accounts, such as a pension, IRA or annuity, and whether those expenses could be deducted from a taxable account. You want to maximize the accumulation of assets inside tax-deferred accounts for as long as possible. Why reduce this amount of assets with expense deductions?

Annuities

Annuities are one of the most, if not the most, expensive products that are sold to investors. If an annuity is recommended to you, ask for the following information:

  • Management fees 
  • Advisory fees 
  • Marketing fees 
  • Mortality fees 
  • Administrative fees 
  • Transaction charges 
  • Termination fees 
  • Maintenance fees 
  • Custodial fees
  • Any other fee that will be charged to you because of the annuity

Fees can be complicated. Don’t buy what an advisor is selling until you have this information and you understand the impact it will have on the achievement of your financial goals. Understand the kinds of financial services you are receiving for the amount of money you are paying.

Paladin Registry offers a ton of free resources for investors to research an advisor and the services he or she provides. Take advantage of this information and educate yourself. Hiring the wrong financial advisor can be a costly and devastating mistake.

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