The cost of investments is a key component of your financial plan. Regardless of whether you work with fee-only advisors or commission-based brokers, portfolio design is likely the largest cost of your plan. So how do you determine what you’re paying?
First, it’s important to determine if you need specific investment recommendations from your advisor. For some people, most or all of their investments are in their 401k. If the 401k has just a few options, it may be enough to understand what your general allocation should be – what percentage in large cap U.S. stocks, what percentage in bonds, and so on. Many advisors – ourselves included – will deliver this as part of the basic financial plan. However, if your situation is more complex, you might need to know exactly what should be bought and sold in each account. If this is the case, portfolio design might be needed.
Commission based brokers often include portfolio design as part of their base fee as the commissions on the products sold are a primary source of income. For fee-only advisors, there is often an additional fee and the fee can either be time based or based on the total value of the portfolio. At Minerva, we charge 0.25% for portfolio design, which equates to $1,250 for a $500,000 portfolio. Add that charge to the hourly fee for the financial planning and you have your total cost for the financial plan plus specific investment recommendations.
For portfolios built of individual stocks and bonds, there are no additional fees – but if you’re using mutual funds, annuities or ETFs, the ongoing fees to those funds will, over time, dwarf the one-time fees listed above. Thus, it’s critical to understand specifically what those fees are. If you work with a broker, it’s likely the fund will pay a commission to the broker that recommends the investment and that commission is known as a load.
It used to be the case that the commissions were paid up front and deducted from the amount invested — so, an investment of $100,000 would actually result in an initial investment of $95,000 for a fund with a front-end load of 5%. However, front-end loaded funds have become less common and funds have moved to covering their commission costs with higher fees over time.
These higher fees – and in fact any ongoing fees – are captured in the mutual fund expense ratio. The expense ratio covers the admin costs of the fund, as well as the fees for the fund manager and in some cases the costs of commissions paid and marketing costs.
Typically, expense ratios on funds sold by commission-based brokers will be higher than expense ratios on funds recommended by fee-only advisors. Because Minerva is fee-only, our funds don’t have commission costs – because no commission is paid – and we typically avoid funds with marketing fees as well.
Your advisor should be able to tell you what the expense ratio of each fund is, or if you’ve got the ticker symbols of the investments, you can find that information on your own on a number of sites, including Morningstar and Yahoo Finance. Again, because these fees are paid annually, they can dwarf the amount you pay up front. Using the $500,000 portfolio as an example, an expense ratio savings of 0.3% means you’ll recoup the $1,250 portfolio design fee in less than 1 year, with ongoing savings of $1500 per year thereafter.
In an upcoming post, I’ll take a look at the total ongoing cost for a plan, investment recommendations, and I’ll also explore a few options to lower those costs, including tax deductions and using the optimal share class.