Investment Fees: Are You Getting Ripped Off?
PBS NewsHour business and economics correspondent Paul Solman weighs in on the often exorbitant management charges of investment firms
PBS NewsHour business and economics correspondent Paul Solman is answering questions from Next Avenue visitors about personal finances, business and the economy. His advice appears on Next Avenue as well as Solman's PBS NewsHour blog, Making Sen$e With Paul Solman, and the Rundown, NewsHour's blog of news and insight.
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I am a retired single nurse and have invested in an IRA and mutual funds managed by a large financial planning firm. Recently I learned that since my portfolio had fallen to less than $500,000, I would incur special management fees. This firm collects its fees based on a percentage of my holdings, currently 1.5 to 1.7 percent, plus other fees I find difficult to calculate. Would I be better off working directly with a low-fee mutual fund (Vanguard or Fidelity) and using its basic "formula" to diversify? — Maureen Clark
I feel passionate about this issue so let me be as blunt as possible.
I think most money management firms are parasites who live handsomely off innocent investors, thanks to marketing pitches that both frighten and reassure customers. I don't mean they're pulling a scam; the majority of money managers, I'm certain, are hard-working and well-meaning.
But it’s hard to argue with the obvious: money management firms pretty much are the market. Therefore, by definition, half of them must be worse than average when it comes to investing your money.
Remember the punch line to the old joke, “What do you call the person who finished last in medical school?”
Substitute "money manager" and you get my point.
Moreover, Maureen, how are you or I to know which managers are in the better half before we commit our money to them? Surely not on the basis of past performance, so famously deficient as a guide to future results. (See this Making Sen$e post from September, where I explain this in somewhat greater detail.)
You describe your money manager as a "financial planning firm." Does the firm help you with taxes? Other financial matters? Does it help you budget? If so, please ignore my cynicism above.
When Does a Fee Become Extravagant?
But if not, what are you paying for? And, by the way, 1.5 to 1.7 percent is a huge management fee. Anything over 1 percent is extravagant these days, unless some extraordinary services are being provided.
You do see the problem, right? These people are paid on commission. The more of your money they can cajole you into entrusting to them, the more money they make. Period.
For any of us non-professional investors, the mantra is simple: Minimize management fees!
How to do that? Invest in the very same funds you do now, but eliminate the middleman.
So, your question is in fact the answer, Maureen: "Work with a low-fee mutual fund directly (Vanguard or Fidelity) and use their basic formula to diversify." I couldn't have put it better myself.
Just make sure to compare the fees of mutual funds you’re considering, so you are investing in the lowest cost funds.