There is always a cost to access the market, but it’s not always clear how it’s being paid. At Halpern Financial we are proud to be completely fee-only, fiduciary, and independent—taking all the steps necessary to put the client’s best interest first.
Unfortunately, there are those in the industry who would rather keep payment structures opaque and difficult to understand. But an educated investor is a successful investor—so we wanted to explain common costs in the industry that can have an impact on your investment success.
Why it Matters How You Pay a Financial Advisor
There are three basic types of financial advisors. To consumers, they may look alike—their websites look the same, and they use many of the same catchwords like “independent,” “financial plan” and “holistic financial advice.” Unfortunately, not all types of advisors deliver on what they advertise, and not all types of advisors have a business structure designed to put the client first.
Brokers and Sales Commissions
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?
“Advisors” who sell commissioned products are legally considered brokers or “registered representatives.” Brokers are employed by or under contract with a brokerage, and as such their first loyalty is to their employer—not the client! There is an inherent incentive for brokers to steer clients towards products with higher commissions (often proprietary products offered by the brokerage firm). These products may or may not be in the client’s best financial interest. Commissions also incentivize frequent trading, which is rarely beneficial to long-term investors.
Even if the broker never does encourage a client to buy a fund that is not in their best interest, the incentive is there.which may not necessarily be what is best for the client. There is nothing stopping a broker from putting his or her own financial best interest before the client.
A fee-based advisor can look very similar to a fee-only advisor. They offer similar services, such as financial planning and portfolio management. They even offer insurance—which can seem like a plus—until you realize that insurance is a commissioned product. This introduces a conflict of interest.
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 participate in any of these commissions whatsoever.
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.”
Some fee-based advisors argue they aren’t paid to sell products either—emphasis on the ‘sell’. This is code for the fact 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.
A fee-only structure puts the client and advisor on the same side of the table because the client pays only for advice. There are different fee-only structures out there (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. They have no incentive to recommend anything other than what is in the best interest of the client. A fee-only advisor will not have the disclosure mentioned in the section above because none is needed. They are not paid by any product, provider or transaction.
The benefit of a fee-only approach is true objectivity and unbiased advice. We are independent of any bank, broker, or insurer—and thus do not get any additional perks for recommending one investment over another. Our only client…is the client! Our incentive is to save our clients money and grow their portfolio, without any focus on which fund will pay us. Our only client…is the client!
However, as mentioned above, the cost of financial advice is separate from the cost to access markets.
Expense Ratios and Transaction Fees
Each individual fund you own in your portfolio has a cost associated with it. At Halpern Financial, we control how much we are willing to pay per fund by selecting funds with low expense ratios and avoiding transaction fees. Our access to Institutional funds keeps costs even lower for investors.
- The expense ratio is how the fund 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. Some advisors can negotiate with their custodian for lower or no fees for transactions. We take great pains to include only mutual funds and exchange-traded funds which trade without a transaction fee. Many investors don’t realize they are overpaying for funds unnecessarily via high expense ratios and transaction fees.
Take our current high yield bond fund for example. It has four share classes, all of which have different expense ratios and types of sales charges, but the underlying investment is the same for all four.
|Fund Name||Symbol||Share Class||Load Type||Front-End Sales Charge||Back-End Sales Charge||Exp. Ratio||12b-1 Fee (part of Exp. Ratio)|
|Intermediate-Term Tax-Free Bond Fund||AXBIX||I Shares (Institutional)||No Load||-||-||0.27%||-|
|TWITX||Retail Investor Shares||No Load||-||-||0.47%%|
We use the institutional (Class I) shares of the fund because it 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 income fund, not a high-growth equity fund. It could take years to recover that initial 4.5% loss of your capital in this fund. 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!
Yet the fund behind all of these fees is the exact same one you could access for just a 0.27% expense ratio if you had access to the Institutional shares. That is about half of the cost you would pay as an individual retail investor! The cost of the A share is more than 18 times the cost of the institutional shares in the first year, and 2.5 times each subsequent year. Again, the fund is the same, but the A share investors' returns will be lower because they are paying a higher cost to access the fund.
So why doesn't everyone use Institutional funds? Not everyone has access to them. 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 our clients.
You should always be aware of what you’re paying. A higher expense ratio does not mean a better chance of investment performance success. 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 Should You Care about Advisor Fees?
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.