Article courtesy of The Motley Fool via “The Rundown”
Hidden fees are almost synonymous with the financial world, particularly financial advisors. Millions of ordinary investors feel the subtle sting of a mutual fund’s egregious “sales load” or the painful pinch of the infamous 12B-1 fee.
But the cost I’m talking about is even more hidden. You probably have no idea you are paying it. You’ll never see it in a prospectus.
In fact, it’s invisible.
One of the most common fees financial advisors charge their clients is the 1% annual fee, based on assets of under management. Every quarter, 0.25% is deducted from the client’s account and slipped in the pocket of the financial advisor’s firm. Even though this katana-like fee structure should be overhauled, this is not the cost I’m talking about — though it’s related.
I’m talking about the future investment opportunity you lose every time that financial advisor deducts from your account each quarter.
Let’s walk through that scenario but put some names and numbers to it.
Laura is a 34-year-old orthodontist. She recently finished paying off her student loans and is approached by a financial advisor who’s graciously willing to manage her $500,000 investment account for a 1% fee per year. Laura paid over 5% interest on her student loans, “Only 1% per year?!” she says, “Sign me up!”
Over the next 10 years, let’s assume the market (and Laura’s portfolio) achieves an inflation-adjusted annualized return of 7% (or 1.71% per quarter).
After 10 years, the value of Laura’s portfolio sits at $892,000.
Over that time period, Laura paid her advisor $68,290. Even an orthodontist would think that’s a pretty-penny to charge for a service.
But at least Laura can clearly see that money being withdrawn from her account every quarter. However, as those quarterly payments flowed out of her account and to the advisor, she is sacrificing all future growth on that forgone money.
Laura’s first quarterly payment to her advisor would have been around $1,271. Had she retained that money in her account for the 10 years, it would be worth $2,459 — nearly double its original value. After 10 years of lost opportunity, that first quarterly fee was actually closer to 0.5% (or 2% annually).
Altogether, over the account’s 10 year history, Laura would be giving up an extra $25,421 in missed returns. Coupled with the actual fees paid, Laura is out nearly $94,000 — $89,000 more than had she put her $500,000 into a Vanguard S&P 500 index that charges 0.05% annually.