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Commission, Fees, and Expenses: What’s the Difference and Why Should You Care?

Personal Finance

“As a fee-only investment advisor, Halpern Financial is committed to providing financial guidance consistent with our fiduciary duty.”

We are proud of that statement on the front page of our website, but there are a few terms in there that require some explanation. Not all advisors are fee-only, and not all are fiduciaries (financial professionals who act in the best interest of their clients). Combine those factors with our status as an independent Registered Investment Advisor and our institutional access to low-cost funds, and you have what makes Halpern Financial different in a nutshell. We believe this combination is the most ethical way to manage money because it avoids any conflict of interest between investor and advisor, and allows investors to access markets in the least costly manner.

There is always a cost to access the market, but it’s not always clear how it’s being paid—so we wanted to explain common costs in the industry that can have an impact on your investment success.

Commission

You pay a commission to your real estate broker, your car salesman, and insurance agent—so what’s the issue with paying your financial advisor a commission?

When advisors are paid via commission, there’s an inherent incentive to steer clients towards the products that will pay the advisor the most. Unfortunately, these products may not be in the client’s best financial interest. Commissions also incentivize frequent trading—even though this is rarely beneficial to long-term investors.

It can be confusing to figure out if an advisor is paid by commissions because both fee-only and fee-based advisors may offer portfolio management and financial planning. The difference is that fee-based advisors may charge fees in addition to commissions from insurance or funds with front-end, back-end, or ongoing commissions (called 12b-1 fees). Fee-only advisors do not.

You can always tell a fee-based advisor because they will have a broker-dealer affiliation on their website or business card. These disclosures come in different forms, but they will look something like: “Securities offered through XYZ Broker, Inc.” or “Individuals associated with ABC Advisors, Inc. are registered with and offer securities and investment advisory services through XYZ Broker, Inc. a registered broker-dealer and investment adviser.”  Halpern Financial has none of these – we are truly independent.  

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Fees

As you might imagine, fees are how fee-only advisors are paid. There are different fee structures out there (ex. quarterly, retainer, hourly) but the main difference between a fee-only advisor and commissioned or fee-based advisors is that fee-only advisors are not compensated based on the sale of a product whatsoever.

Some fee-based advisors argue they aren’t paid on a product either—emphasis on the ‘sell’. What they aren’t saying is that they may get an ongoing 12b-1 fee throughout the time you own the product. We avoid funds with 12b-1 fees because they are a constant cost that drags down investor returns.

When we say we are not paid on the sale of a product, we mean it. The benefit of this is true objectivity and unbiased advice because we don’t get any additional perks for recommending one investment over another. Our incentive is to save you money and grow your portfolio, without any focus on which fund will pay us.

Which brings us to…

Expense Ratios and Transaction Fees

There is always a cost to access investments, but we can control how much we are willing to pay per fund by selecting funds with low expense ratios and avoiding transaction fees.

  • The expense ratio is how managers who select, buy, and sell the stocks and bonds in a Mutual Fund or Exchange Traded Fund are compensated. Expense ratios are included in the price of both types of funds, so often people are unaware of how much they are really paying.
  • The transaction fee varies by custodian. We take great pains to include only mutual funds and exchange-traded funds which trade without a transaction fee through your custodian, Fidelity Institutional.

Many investors don’t realize they are overpaying for funds unnecessarily via high expense ratios and transaction fees.

Take our current international bond fund for example. It has three share classes, all of which have different expense ratios and types of sales charges, but the underlying investment is the same for all three.

Fund NameSymbolShare ClassFee StatusLoad TypeFront-End Sales ChargeBack-End Sales ChargeExp. Ratio12b-1 Fee (part of Exp. Ratio)
Deutsche High Income Bond Fund BOND FUNDKHYIXClass INo Transaction FeeNo Load--0.71%-
KHYAXClass ANo Transaction FeeFront-End4.50%-0.94%0.23%
KHYCXClass CTransaction
Fee
Back-End-1.00%1.76%1.00%

We use the institutional (Class I) shares of KHYIX which, as you can see, has the lowest expense ratio, no transaction fee, no 12b-1 fee, and no front-end or back-end sales charge.  These add up to significant savings.   

You can see what a difference it makes. You could be paying 4.5% to buy the Class A shares—and as if that wasn’t painful enough, this is a bond fund. Even though the Federal Reserve is slowly raising rates, we are still in a historically low interest rate environment. The fund is highly unlikely to make up your 4.5% anytime soon. And the Class C shares have an ongoing 12b-1 fee, a back-end sales charge on the entire value of your fund when you sell it, and a transaction fee. Ouch!

Remember—the fund behind all of these fees is the exact same fund you could access for just a 0.71% expense ratio.

But say you’re not interested in this particular bond fund. The same idea holds true for one of the most common investments—an S&P 500 index fund. The institutional class of the Fidelity S&P500 Index Fund has an expense ratio of just 0.035%.  That’s more than 60% lower than the cost you would pay to buy the same fund as an individual retail investor (0.09%).

 Not everyone has access to institutional-level pricing. Institutional-class funds have the lowest expense ratios, but they often have prohibitively high minimums to invest (as much as $5 million per fund, per account). Think of it as ‘bulk discount pricing’ for investments. Halpern Financial is proud to offer institutional-level funds for all of our clients.

You should always be aware of what you’re paying, and don’t get roped into thinking you will get a higher return the more you pay in fees and expenses. In fact, the opposite is true—the less you pay in expenses, the more you have available in your pocket to grow and compound over time.

You can find the expense ratio of funds you own on Morningstar or by reading the fund prospectuses.

Why do you care?

As an investor you should examine every cost associated with your financial life. Are you getting value for what you’re paying?

At Halpern Financial, we are fiduciaries. Digging into the cost structure of your investments is just one way we uphold that fiduciary standard, seeking the best outcomes for our clients at the lowest cost possible.

And it’s a win-win for us too—by doing the right thing for our clients every day, we have every incentive to be completely transparent and help our clients to be well-educated financial consumers. 

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IMPORTANT DISCLOSURE INFORMATION

  Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Halpern Financial, Inc.), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Halpern Financial, Inc. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Halpern Financial, Inc. is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the Halpern Financial, Inc.’s current written disclosure statement discussing our advisory services and fees is available for review upon request.


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