Is Your Portfolio Costing You Too Much?

NOVEMBER 12, 2018
David Robinson, CFP
One thing investors hire advisors for is to keep their portfolio fees down. Yet, according to a study by the CFA Institute released in March, only about 48 percent of advisory clients are satisfied that they’re getting enough information on fees. investment portfolio fees

And some clients’ fund fees are probably much higher than they know. They may be aware of how much they’re paying their advisor, but perhaps not what they’re paying on various investments their advisor has gotten them into.

As a result, they may have little idea of how much their portfolios are actually costing them and thus, no idea of how effective their advisor is at keeping down costs. Advisors who take good care of their clients’ assets should be seeking to minimize portfolio fees because this can make a big difference in net returns.

Typically, clients pay their advisors around 1 percent a year on the total value of investments under management (AUM), depending on the size of the account. But what they pay in internal fees—the annual amounts investment companies are charging you—comes atop their advisor’s fee.

This issue should be a point of discussion for client-advisor meetings, especially during the portfolio-construction phase.  At such meetings, there should be discussion of what kind of investment vehicles are being recommended for your portfolio.

Many actively managed funds, such as mutual funds where highly paid fund managers buy and sell stocks for the fund’s shareholders, tend to have annual expense ratios (basically, expenses including fees) greater than 1 percent.

According to a survey by the Investment Company Institute, a global association of regulated funds, the average basic expense ratio for equity mutual funds in the U.S. in 2017 was 1.25 percent.

Expense ratios for passive investments—those that track indexes (such as the S&P 500) instead of buying and selling stocks—tend to be lower, averaging 0.74 percent, according to Morningstar Investment Research. And expense ratios tend to be even lower for passively managed exchanged-traded funds (ETFs) which, like index funds, track indexes (but unlike them, can be bought and sold during the trading day). Equity ETFs have an average expense ratio of 0.44 percent, according to Morningstar. At this rate, you pay $44 in annual fees for every $10,000 invested.

It’s important to remember that these are average figures. If your advisor told you when assembling your portfolio that much of your wealth would be invested in ETFs because they typically have low expenses, the question is: What ETFs? And what are their expenses?

Clients don’t know because they typically don’t ask their advisors. They could look up the fees for each fund online by using the ticker symbol, but they seldom do this.

If you own index funds or ETFs that charge an average of 0.90 percent annually, add to that your advisor’s annual fee. If that fee is 1 percent fee, the total figure you’re paying is about 2 percent a year, not including fund turnover costs. So, if your gross investment returns are 4 percent a year, you have a net gain of only 2 percent. But with annual inflation currently running about 2 percent, you’d actually be getting negative returns.

Ideally, you want internal portfolio expenses totaling maybe .05 to .10 percent. This goal, which isn’t achieved by many advisors, can be reached by investments with low average expenses and other selective techniques. Of course, low expenses aren’t the only goal. It’s also important to choose funds whose equity ownership is consistent with your asset allocation—the proportions of your portfolio dedicated to different types of investments (in this case, different types of equities in different sectors).

With actively managed mutual funds, a key factor that can significantly raise fees is the turnover ratio—how much of a fund’s investments are sold and replaced over a year, compared with the total number of investments in the fund. A low turnover ratio is considered to be 15 percent or below. The closer you get to a turnover ratio of 100 percent, the more this can cost you. The average turnover ratio for such funds is about 60 percent—which can increase internal portfolio fees from .5 to 1 percent.

If your portfolio’s internal expenses are sky high, this raises larger questions about the value your advisor is providing. To properly assess your advisor’s value, you should have a full understanding of just what services they’re providing. Wealth managers not only oversee investment portfolios, but also advise clients on estate planning and cash-flow management, among other services. Unfortunately, some advisors call themselves wealth managers without actually providing such services.

Chief among these other services are tax planning and tax-efficient portfolio management. The latter can make a significant difference in annual portfolio returns, says Mark Fiedler, CFA, of AUTUS Asset Management. Numerous academic studies over the years have consistently shown that, without proper tax management, “taxes can erode as much as 2 percent of a client’s investment returns in a given year,” Fiedler explains. While this number can vary greatly depending of the client’s specific situation, he adds, tax efficiency is generally “critical to long-term portfolio outcomes.”

If your advisor is truly a wealth manager and you’re receiving services in return for just the 1 percent AUM fee, you’re getting a much better value than if the only thing he or she does is quarterback your investment portfolio; you’re getting the gold standard in advisor value.

Regardless of what services your advisor is performing for you, he or she should be able to readily provide all fee information. All you have to do ask.

David Robinson, a Certified Financial Planner, is founder/CEO of RTS Private Wealth Management, an SEC-registered firm in Phoenix that provides fiduciary services to help clients achieve their financial goals. His practice focuses on helping wealthy individuals with custom financial plans, using a holistic approach to grow/protect wealth, manage taxes, identify insurance solutions, prepare for retirement and manage estate plans.
 

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