I’ll continue to refer to the SEC’s website to continue our discussion of fees.
The Securities and Exchange Commission (SEC) lists how investment advisors get paid. http://www.sec.gov/investor/pubs/invadvisers.htm
Q: How do investment advisers get paid?
A: Before you hire any financial professional-whether it’s a stockbroker, a financial planner, or an investment adviser-you should always find out and make sure you understand how that person gets paid. Investment advisers generally are paid in any of the following ways:
- A percentage of the value of the assets they manage for you;
- An hourly fee for the time they spend working for you;
- A fixed fee;
- A commission on the securities they sell; or
- Some combination of the above.
In Part 1 of this article I talked in more detail about a percentage of the value of the assets they manage for you. Now I will describe the remaining ways investors pay their investment advisers.
An hourly fee for the time they spend working for you
This is pretty straightforward. An advisor may choose to charge for services by the hour. They charge an hourly rate for time spent on communication through phone, personal contact, email, and managing your assets. I find this fee schedule is more common with advisors who provide both financial planning and investment advisory services. In some instances, there may be an hourly rate for the advisor’s time and a lesser rate for the time an administrative person works on a client’s account.
A fixed fee:
An advisor may assess the services required and estimate the time required to complete the work. They will set a fixed fee. The fee may be split, a portion up front with the remaining at the completion of their work, all up front, or all at completion. Fixed fee for financial planning is quite common, with $2,000-$5,000 being a common range. Of course, the complexity of your situation will determine this rate. If the financial planner is going to manage your investments, they may charge for that service using one of the fee schedules above.
A commission on the securities they sell:
Each transaction, the purchase or sale of a stock, generates a sales charge called a commission. The commission is calculated as a percentage of the transaction or as a flat fee. These charges change from brokerage firm to brokerage firm, and even within the same brokerage firm. A firm may have commission rates based on the size of the transaction and client’s portfolio size.
There are significant fee differences between discount brokerage and full-service brokerage commissions.
Full-service Broker: If you rely on a broker to recommend stocks to buy and sell and to make the trade, commission charged for each transaction may start at $35 and go higher. Let’s say your broker recommends you sell $1,000 of ABC company and buy $1,000 of XYZ company. Let’s also assume the commission is $40 per trade. The commission charged to your account will be $80. $40 to sell ABC and $40 to buy XYZ. Commissions amount to 8% (80/1000). The stock has to rise 8% before you begin making any money.
Discount Broker: If you decide what stocks you want to buy and sell, you can use a discount broker. Online trades range from $4 – $20 and you either make the trade yourself (cheapest) or call the broker to make the trade. If we use the same example from above except use a $10 commission, our cost is $20 or 2% of the stock value. You keep 6% in your account.
Sales Charge (Load) on Purchases
A sales load is like a commission investors pay when they purchase a security through a broker. Mutual funds that use brokers to sell their shares typically compensate them by imposing a fee on investors, known as a “sales load” (or “sales charge (load)”), which is paid to the selling brokers.
There are two general types of sales loads-a front-end sales load investors pay when they purchase fund shares and a back-end or deferred sales load investors pay when they redeem their shares.
Front-end Sales Charge (Load) on Purchases
The Front-end Sales Charge (Load) on Purchases is the amount investors pay when they purchase fund shares. The key point to keep in mind about a front-end sales load is it reduces the amount available to purchase fund shares.
Example: if an investor writes a $10,000 check to purchase mutual fund shares, and the fund has a 5% front-end sales load, the total amount of the sales load will be $500. The $500 sales load is first deducted from the $10,000 check (and typically paid to a selling broker), and assuming no other front-end fees, the remaining $9,500 is used to purchase fund shares for the investor.
Deferred Sales Charge (Load)
The Deferred Sales Charge (Back-end Load) investors pay when they redeem fund shares (that is, sell their shares back to the fund).
Example: if an investor invests $10,000 in a fund with a 5% back-end sales load, and if there are no other “purchase fees,” the entire $10,000 will be used to purchase fund shares, and the 5% sales load is not deducted until the investor redeems his or her shares, at which point the fee is deducted from the amount redeemed. Back-end loads may decline over time. A 5% charge may decrease by 1% each year. Example: year 1 a 5% fee is paid if an investor sells the fund, year 2, 4%; year 3, 3%….. year 6, 0%.
A fund with a contingent deferred sales load typically will also have an annual 12b-1 fee, a portion up to .25% is typically paid to the broker.
To learn more about mutual fund expenses and fees go to http://www.sec.gov/answers/mffees.htm#distribution
Some combinations of the above.
Some advisors charge a percentage of the assets value and receive commissions.
There are advisors who charge an hourly fee or a flat fee for certain services plus a percentage of the portfolio value for managing your investments.
There are certainly other combinations, so be sure to read the agreement or contract and then ask the advisor to explain “how do you get paid?”.