21 Ways To Reduce Investment Management Fees
There’s never been a time when it ‘s made more sense to control investment management fees. Years ago, when you expected a balanced portfolio to deliver an average return of 10%, a 2% fee might have been OK. But when expected returns are closer to 4% you have to realize that although you’re taking 100% of the risk, a 2% fee would eat up half of your total return.
Other things being equal, a higher fee means a lower return. We should remember, however, that the main objective is not to minimize fees; the main objective is to achieve your goals. If a reasonable fee increases the odds of achieving your goals, that fee is justified.
Investors want value for the fees they pay. If no value is received, even a tiny fee is too much. And we measure whether value has been received by comparing actual results with the appropriate benchmark.
Investors have to be careful not to “cut off their noses to spite their faces”. It does not make sense for an investor to focus on minimizing fees if they would get better service and a better rate of return by paying a reasonable fee. Having said that, if you want to focus on minimizing fees, here are 21 points to consider.
1. Ask for a discount. Many financial advisors will offer a discount if you ask for it. No advisor offers a discount if you seem quite happy with the higher fee. The best time to ask for a discount is when you are starting a new relationship – before you sign the application form. However, if you’ve been with the same advisor for 10 or 15 years, you should know that fees are generally lower than they were when you first signed on as a client. If new clients are paying a lower fee - maybe you should as well!
2. ‘Buy and hold’ is the strategy that triggers the lowest fees. This strategy also defers the payment of capital gains tax. The disadvantage of ‘buy and hold’ is that you don’t get to lock in profits by rebalancing. And in the absence of rebalancing, your portfolio may eventually become higher-risk as the allocation to equities is expected to grow faster than the allocation to fixed income.
3. Use some exchange traded funds (ETFs) in your portfolio. Index-tracking ETFs have lower fees than mutual funds and your return will be close to the return of the market. A portfolio of ETFs will likely give you a better return than a portfolio of stocks that you pick on your own or that your advisor recommends.
4. Be a do-it-yourself (DIY) investor. Most DIY investors should use an ETF ‘couch potato’ type of portfolio rather than using individual stocks. DIY investors can be blind to their own shortcomings so they need to measure their performance compared to an ETF ‘couch potato’ type of portfolio with the same level of risk. Many DIY investors would fire themselves if they measure their performance compared to an appropriate benchmark.
5. Use robo-advisors. Robo-advisors are a class of financial advisors that provide online portfolio management services with minimal human intervention. Most robo-advisors employ algorithms such as Modern Portfolio Theory to rebalance ETF portfolios. Fees are a bit higher than a DIY investor using ETFs – but the disciplined rebalancing should more than offset the slightly higher fees. A big plus is that robo-advisors are licensed as portfolio managers and are therefore required to adhere to the ‘fiduciary’ standard which gives investors more protection than the ‘suitability’ standard that is adhered to by most financial advisors.
6. Use a Private Investment Counsel (PIC) firm. These are the true professionals within the financial services industry and they offer active rather than passive investment management. PIC firms have lower fees than mutual funds and full service bank advisors, they follow a disciplined investment process, and they offer better performance reporting. They also adhere to the fiduciary standard.
7. Pay commissions rather than being in a fee-based account. In a well-managed account there will be few transactions so paying normal commissions per trade will usually mean lower overall costs than paying an annual fee based on the size of the account. And it makes no sense to be paying a management fee on cash or any securities which you never intend to sell.
8. Ask for a written description of all fees that will be paid. When it’s going to be put in writing, advisors are more careful about making estimates of fees (and they are more likely to mention the imbedded fees that you pay indirectly).
9. Avoid ‘structured products’. The highest fees and costs (largely hidden) are found in structured products that usually have some sort of guarantee that you’ll get your capital back. But it’s a mistake to pay a high fee for a product that will reduce volatility during the period when you don’t need the money – if by accepting some volatility you’ll have more money when you do need it. You should be comfortable with the volatility associated with the asset mix necessary to get the rate of return needed to achieve your goals. If you’re not comfortable with this level of volatility, it’s better to reduce spending rather than to pay the high fee associated with structured products.
10. Avoid performance fees. Performance fees are usually found in hedge funds and you need to ensure that the ‘hurdle rate’ and the ‘high water’ mark make sense. Be aware that a performance fee creates an incentive for the investment manager to take higher risk with your money.
11. Don’t be a frequent trader. Frequent trading is usually a sign that the investor is acting based on an emotional response rather than following a disciplined investment process. It would be unusual for market conditions to dictate a rebalancing more than once per year. Someone once said that an investment portfolio is like a bar of soap – the more it is handled, the smaller it becomes.
12. Consolidate your accounts with one advisor. Usually the more assets an advisor is managing, the lower the fee will be. But you should only consolidate if the one advisor follows a disciplined investment process, creates a ‘goals based’ asset allocation, provides an investment policy statement that shows benchmarks and is in sufficient detail to hold the advisor accountable, provides performance reports that show performance compared to the benchmarks, and uses ‘best in class’ rather than ‘in house’ managers.
13. Know your Trading Expense Ratios (TERs). The TER is in addition to the Management Expense Ratio (MER). The TER typically adds between .01% and 1% (average is about .15%) to the annual cost. The TER comparisons are most useful when comparing similar types of investment mandates.
14. Avoid balanced funds. The MER for one large balanced fund (70% equities and 30% fixed income) is 2.48%. This is about 10% higher than the total of the MER in a portfolio with 70% in an equity fund (MER is 2.5%) and 30% in a fixed income fund (MER is 1.62%). Note: while the fee will likely be higher with a balanced fund, the higher fee may be justified since the benefit of the rebalancing will likely more than offset the higher cost.
15. Avoid deferred sales charge (DSC) mutual funds. Typically the sales charge on these funds is 6% and declines to 0% in 5 to 7 years. The commission earned by advisors is usually 5% up front. An additional problem with DSC funds is that investors feel locked in and are reluctant to move out of a DSC fund even if the manager is consistently underperforming compared to his or her peers.
16. Avoid Initial Public Offerings (IPOs). In a recent article by Matt Krantz (author of five books on investing), he explains that between the 2nd quarter of 2013 and the 1St quarter of 2014, more than two-thirds of new IPOs fell short. With an IPO the advisor typically earns a commission of 5%. Investors can often do better by avoiding the Initial Public Offering and buying the stock at a lower price in about one year’s time.
17. Avoid Segregated Mutual funds. Segregated mutual funds are a type of high-fee mutual funds (MER usually over 3%) which have benefits including guarantees at death or maturity, creditor protection, avoidance of probate, and the ability to lock in profits with ‘resets’. Typically investors have to hold the funds for 15 years to get a 100% guarantee. It would be unlikely that over a 15-year period there would be no growth in a well-balanced investment – so a guarantee that only gives you back your capital in 15 years is of questionable value.
18. Know how commissions on bonds is calculated. Investors should be aware that the commissions on bond purchases (including strip bonds) is usually calculated on the higher maturity value of the bond – not on the purchase price.
19. Consolidate to get Premium Pricing. Some fund companies will reduce the MER by 10 to 30 basis points if a family unit has more than $100,000 invested in the funds of a single fund company. Some fund companies have expanded the definition of ‘household’ to encourage this type of consolidation.
20. Make the investment management fee income tax deductible. The MER for a mutual fund or ETF is paid by the fund itself and is therefore not immediately deductible to the investor in the fund. On the other hand, the fees charged by investment counsel firms are billed and paid directly by the investor and are therefore income tax deductible (if not for registered accounts).
21. Change advisors. Investment management fees are lower today than they were 10 or 15 years ago. Most advisors who are opening up new accounts today are charging a lower fee than they did to open up the same size of account 10 years ago. If you have been with the same advisor for over 15 years and the fee has not changed – it may be possible to get a lower fee just by shopping around.
What’s a reasonable fee to pay for the complete service including advice, financial planning, portfolio design, investment management, rebalancing between managers, transaction costs, pool operating costs and custodian costs? A recent study of investment counsel firms shows that for a $1,000,000 portfolio, the fee range for all of the above services is between 1% and 2.25%--with the most common fee being about 1.35% per annum.
Oscar Wilde is quoted as saying:
A cynic is a person who knows the cost of everything but
the value of nothing.
Wise investors will pay attention to fees but their primary focus will be on determining whether value is received for any fees paid.
Fees are important but the ‘after fee’ performance is even more important. Unfortunately few investors receive a performance report which shows how they’re doing compared to the appropriate benchmark. If investors don’t know if they are on track to achieve their goals or how they are performing compared to the proper benchmarks, they’ll not know whether or not they are receiving value for the fees they pay. In my experience most investors who are not measuring performance compared to a proper benchmark are underperforming the benchmark by about 2% per annum. If a 2% higher return would make a difference to you, you really should measure your performance compared to the proper benchmark.
Next Step:
Take the test at http://www.weighhouse.com/resources/is_it_time_to_fire_yourself.aspx. If you pass the test, continue doing what you’re doing. If you fail the test, give me a call and if I can help I’ll give you a proposal (with full disclosure of all fees) for my services.
Warren MacKenzie, CPA,CA is the founder of Weigh House Investor Services and a Stewardship Counsellor with HighView Financial Group. Email: warren.mackenzie@weighhouse.com Tel. (416) 640-0550