Investment management fees are typically charged as a percentage of the total account value and can range from 1% to 2%. What many investors fail to realize is that embedded fees can drive the true cost of money management upwards of 3%. These embedded fees are typically associated with investment products such as mutual funds and annuities. The vast majority of financial advisors, especially those employed by big banks, utilize these products because they are paid commissions by the mutual fund and insurance companies for doing so. Mutual funds and annuities are expensive, legacy products that typically do not add any value to a client’s portfolio and should be avoided at all cost.
Over a long-term period, a few percentage points of variation in investment fees can have a dramatic impact on the appreciation of assets.
For a $100,000 investment made in the U.S. stock market in 1988:
While many investors are often dismissive about investment management fees or simply fail to quantify their effects, it comes at a detrimental cost to the appreciation of their assets.
Investment management fees can be structured in a variety of way other than traditional asset-based fees. Certain investors are eligible to engage in a performance-based fee structure in which the investment adviser is compensated based on a share of capital gains and only makes money when the client does. An annual flat-rate fee can also be implemented for most accounts.
It is absolutely not worth paying an investment manager to simply buy mutual funds or to randomly pick stocks and/or exchange-traded funds (ETFs). Investment advisers that advertise themselves as active managers should only be compensated for adding value by outperforming the referenced benchmark index over a multi-year period.
Fees are one of the single most important aspects of professional money management that investors must take into account when deciding how to allocate their assets. The vast majority of investment managers cannot justify fees that exceed 1% and investors must be conscious of those fees that are embedded in various financial products like mutual funds and ETFs. Once the aggregate fee rate is determined, only then can investors make informed decisions about how much they are actually paying. The key takeaway is that over long periods of time, even a fractional percentage variation in annual fees can have a drastic impact on investment returns.