Understanding the Real Costs of Your Investments

What is the value of good advice?

By Daniel Cohen

Daniel Cohen bringing the trading to order at the New Your Stock Exchange in February, 2013

Daniel Cohen bringing the trading to order at the New York Stock Exchange in February, 2013

After working as an investment advisor for several of the largest banks in the world for the previous twenty years, I formed an independent registered investment advisory firm.  Thankfully, after less than six months in business, more than ninety-five percent of my clients have transitioned to the new firm, and more are expected in the coming months.

Most business owners and other professionals would like to see everyone who walks in their front door become a client, but no one can win them all.  Sometimes the best lessons come from the client that left or the prospect that went somewhere else.  In my case, I will try to learn from a client that chose not to transition their account with me.  Coincidentally, this same client was the subject of a previous article I wrote for the New Hampshire Business Review titled “The Mistake of Not Seeking Professional Advice,” from March 7, 2013.

In the 2013 article, I commented that when this client inherited money from a parent, part of the inheritance was in a retirement account.  Three siblings were equal beneficiaries of the estate, and they chose to cash out of the retirement account and distribute the funds equally.  If they had sought advice prior to making their distribution decision, they would have been informed that they could have kept the funds in retirement accounts and continued to defer the taxes.  Setting up inherited retirement accounts could have saved each beneficiary thousands of dollars in immediate taxes.  In the case of multiple beneficiaries, some can choose to continue deferring taxes while others can take their full distribution immediately.  This client came to me after the distribution decision was already made so I couldn’t change their decision.

At the time I made the transition to become an independent investment advisor, this client had been doing business with me for eighteen months.  The portfolio had been invested in equities as growth was the primary objective, and the equity market had one of the best years in the past twenty.  This client had very good gains, expressed that my service was excellent, but then decided not to continue to do business with me.  After many months of wondering why a client would leave me after earning excellent returns and having received excellent service, this client let me know that they found an advisor that was charging a lower fee.

This is not the first time I lost business to another advisor that was “charging a lower fee.”  The important question to ask is whether the client or prospective client is paying more or less based on the decision they make.  In the equity portfolios that I manage for my clients, I almost exclusively invest in shares of stocks of balance.ci1leading companies like Disney, Procter & Gamble, Johnson & Johnson, Home Depot, and Apple.  I charge an advisory fee to manage my clients’ portfolios, and that is the only fee my clients pay my firm. There is no additional expense to hold shares of individual stocks.  Many advisors charge an advisory fee and then invest in mutual funds for their clients.  Mutual funds do have their own internal expenses which are a cost to the owner of the fund.  So in these cases, clients are paying their advisor two layers of expense: one layer to the advisor and the second layer to the mutual fund company.  In many cases the total expense can approach or exceed two percentage points.  Moreover, some advisors not only charge an advisory fee, but they also charge additional fees for completing a financial plan.

There is nothing wrong with investing in mutual funds and there is nothing wrong with paying an advisor for a financial plan.  But, an investor should be aware what their total cost for the advice and services are from their advisor and from their investment choices.  According to the Vanguard web site, the industry average expense ratio of variable annuities is 2.28%.  I have heard from many investors that think they are paying nothing to own a variable annuity.  The Wall Street Journal recently reported that the average fee for an alternative mutual fund is 1.9% and these high cost funds have been attracting large inflows of funds and sometimes are on top of the advisory fees being paid.

Many investors place their trust in a financial service professional to provide educated, experienced advice on how to invest their hard earned money.  They are willing to pay someone else a fee to invest on their behalf because they have neither the time nor the interest in learning all they can about financial markets.  Investment options are exhaustive:  publicly traded stocks, bonds, mutual funds, money market funds, variable rate and fixed annuities, precious metals, REITs, and more.  It can all be overwhelming to the average investor.  It makes a lot of financial sense to find an advisor, that you can trust, preferable one with the Certified Financial Planner (CFP®) certification, who can work closely with you in an objective and customized manner, unique to your particular life situation and whose fees are transparent and easy to understand.advisor.1

I have a very low turnover ratio of clients.  This means that once a client hires me, they tend to stay with me for a long time.  The client mentioned earlier, who left my firm for another advisor because of a lower fee, may read this article and realize that they are actually now paying more for their investment advice considering the extra layer of fees being paid for the mutual funds held in the portfolio. And what about the results in returns?

A similar situation occurred when a perspective client came to me in the past year having read an article I wrote for New Hampshire Business Review and also ended up choosing another advisor based on a lower fee, but once again the total cost of the multiple layers of fees wasn’t considered.  My hope is that my lost client will come back to continue the relationship.  But, we can’t win them all.  Perhaps there will be a future article about this same client.