People have claimed for years, I being one of them, that the investment world is wrought with hidden fees. There is the spread between bid and ask prices that goes to someone. There is the expense ratio in mutual funds that is spread out to many different individuals and entities. That expense includes (12b-1) fees that are paid back to the salesman or broker and that is in addition to the up-front fees that many share classes pay at varying levels. There is the marketing fee that is paid to enhance shelf space at investment firms. And the one fee that I feel is hardest to figure out — the trading costs of mutual funds. Now, we haven’t even begun to talk about bond spreads, initial offering fees, such as incurred in closed-end funds, fees built into certificates of deposit, etc., etc., etc. I can go on and on. Some fees are disclosed in the small print of brochures that investors are required to receive when purchasing an investment. Although, those brochures are so hard to read I would be surprised if one out of a hundred people really understand them. Some fees are never disclosed. For example, we know that there is a difference between the bid price and the ask price on a stock or bond trade, but where does the money in the middle go?
The better question might be, “Why don’t more investors seem to care?” From my viewpoint, one of the problems in our industry is that a large percentage of investors would rather just not know. If they know then they have to consider fees in their decision-making process. In many cases they would just as soon pretend that they are getting their advice, brokerage services, or insurance products for free. We all know that it doesn’t make sense but it seems the more we don’t know, the happier we are. If you happen to earn 7 percent this year on your investments instead of 8 percent you can find a way for that to make sense. But if the difference happened because of hidden fees, that’s $1,000 in fees you didn’t know about. Year after year of paying too much in fees can be a significant drain on your return.
People need to understand fees. It is a fiduciary requirement if you are in charge of handling someone else’s money and it should be important to those handling their own money as well. The new Financial Reform bill is going to help. The bill is going to require that fees are easier to understand and are fully disclosed. As a matter of fact, by the first of 2011 retirement plans are going to be required to disclose in understandable language how much they incur in fees and where those fees go.
Don’t get sticker shock when you become enlightened. It just might be more money than you thought. Understanding what fees are involved in different investments can be very helpful in making decisions. For instance, let’s say you are looking for an income generating investment and you have narrowed it down to a five year bond, an income fund that has bonds and stocks and a bond mutual fund. At this point it might be helpful to know how much each one costs. On a $100,000 investment, the difference could be as much as $5,000 over a five-year period of time in some of the investments I researched for this column. That would be good to know, wouldn’t it?
You may decide to pay up for certain investments, and I would be the first to say that it is appropriate to pay up if you are getting your money’s worth. But how can you make that decision until you know those numbers? Our industry is trying to address the problem of hidden fees, but there are a lot of groups that would rather you not know. So maybe it is time for the investors to show that they care, too. Maybe it’s time for investors to begin demanding to know how much they are paying and what they are getting for their money. Maybe the time is now while we have the momentum to get something done.
Scott Reed, CIMA, AIFA, is CEO of Hardy Reed Capital Advisors in Tupelo.