What is "Free" Investment Management?

Is there such a thing as “Free” for Investment Management?

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You may have noticed recently that banks and financial service companies are offering “free” services with no management fees. However, is there any such thing as a free lunch?  The short answer: NO.  As illustrated through the image above – you are likely flushing money away through hidden fees.  While there may be no management fee, you are likely paying more for the specific funds placed in your security. At the end of the year, you may find that your hidden fees add up to much more than the industry standard management fee.  These products don’t always serve your best interests and often create continuous commissions and profits for the advisor and the firm.

In this first of a series of blogs, we will dive into the fees you pay when you buy mutual funds.     In our future blogs we will help you find the fees in your bonds, stocks, mutual funds, closed-end funds, new issues, and other investments.  In this blog series, we will address several expenses that can hurt your overall performance and reduce your wealth. Over the coming weeks, you will learn about other products that may be placed in your portfolio, such as closed-end funds, bonds, structured products, and Private REITs, that have hidden fees associated with them. Today’s topic is Mutual Funds. Our goal is to empower you with valuable information that may help you understand how commission-based, financial salespeople think, and how they reach sales goals for themselves and their company.

MUTUAL FUND

Mutual funds come in many forms. Typically, you can purchase Class A, B, or C shares. These classes have different fee structures.  Let’s look at a class C-Class (“C” refers to the fee percent staying the same year after year) fund like FAFCX.  C funds have a level, annual fee schedule that includes charges for marketing, distribution, and servicing (aka management fee). If you go to yahoo finance and type in the ticker symbol, FAFCX, it will open a page that provides several pieces of data about this Fidelity Class C Mutual Fund. One of the numbers you will find is the expense ratio on the left-hand side. You’ll notice a 1.86% fee. This number may not be helpful unless it’s placed into a context that compares this rate to other funds available in the market space. An example will help bring clarity to this internal fund expense.

Related Reads: Why ETFs are a Better Choice Than Mutual Funds

Let’s say you have $300,000 to invest, and your advisor purchases FAFCX as your security solution.  Due to the expense ratio, your annual fees are approximately $5,600 (see the chart below).  That is a significant cost for a “free” service. To make matters worse, you pay this fee year-over-year for the duration you hold the fund.  A more profound question to ask yourself, “Is there a less expensive option available that can produce similar results?”  The answer is YES.  Below, the very same firm, Fidelity, offers a similar fund packaged as an Exchange-Traded Fund (ETF) rather than a Mutual Fund.  When you do the math, it’s 20 times cheaper than FAFCX, meaning you save almost $5,400 or 95% of your costs annually! That savings can add up to big bucks over five years. ETFs do not enjoy the free trades that Mutual Funds receive, but we would rather pay a small trading cost ($7 at TD Ameritrade and $5 at Schwab) to get a potential $25,000 savings over five years. Here’s a breakdown in the chart below.

Related Reads: Four Tax Efficient Investment Strategies

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Armed with this information, you can visit your bank representative, or private wealth advisor at a broker-dealer, to discuss why you are being charged fees when you were told: “free.” As your advisor adjusts your security holdings, you will need to be careful that your C share isn’t replaced by a Class-A share fund instead.  Class-A shares are less expensive, typically, than a Class-C share mutual fund. However, Class-A shares are “front-loaded”, meaning you pay expenses upfront in exchange for lower annual fees. This typically includes a 12b-1 fee for marketing and distribution costs that are not represented in the expense ratio.  Instead, these fees are usually disclosed in the prospectus.  This means your advisor is getting paid for five years of commissions at the point of purchase.  To break even on fees, you must hold the fund for 5+ years.  Take the same $300,000 investment from the example above and invest it in a Class-A fund, FAFDX, to a similar ETF this time.

fee comparison between mutual fund and ETF example (A-class).

Does that look free?  Not at all, even if you monitored the portfolio value, or diligently looked at your statement, it’s not factored into your performance data and not disclosed on these documents.  Hidden fees can add up over time. “Free” isn’t free.  In the financial services industry, “free” is more likely attributed to hidden costs. Reasonably priced mutual funds exist, just as there are plenty of ETFs that we would not recommend for your portfolio.  For comparison, we used the ETF (FNCL) for the examples above (this is not a recommendation).  Since there is no clear-cut way to ascertain the total cost of funds quickly, how can you ensure that you have a portfolio designed efficiently and specifically for you?

Lighthouse Financial Services, Inc. is a Fee-Only Registered Investment Advisory Firm. This means that we not only refuse any commission or kickbacks for investment selections, but we carry a fiduciary obligation to put your interests first. We provide a clear fee structure based on assets under management. No hidden fees.No misleading marketing. We never use the word free unless it truly is free. Lighthouse Financial helps clients match investment goals and objectives to best-fit holdings, not with the high commission products.

Give us a call at (714)-572-8900 to set your appointment or directly schedule your appointment below.


*The foregoing content reflects the author's personal opinions which may not coincide with the opinions of the firm, and are subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that these statements, opinions, or forecasts provided herein will prove to be correct. Past performance is not a guarantee of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. All investing involves risk. Asset allocation and diversification does not ensure a profit or protect against a loss. Finally, please understand that–as with other social media–if you leave a comment, it will be made public.