What Are You Paying for Financial Services?

7 Things You Need to Know

By Thomas W. Batterman

It is extremely difficult for an individual investor with average investment experience to determine exactly what they are paying for the financial services they are receiving. In most cases there is more to the compensation story than meets the untrained eye. While not technically meeting the definition of "misleading", many financial services providers use terms to describe their compensation which confuse rather than clarify the issue. In our own, admittedly unscientific, survey of respondents to our website, a majority of respondents failed to properly identify costs they were incurring in connection with management of their financial affairs.

Here are 7 things to look out for when you are considering what it is costing you for the financial advice and other services you are receiving:

1. Commissions. These are charges that you pay for transacting investment transactions with a broker. These charges vary substantially based upon the broker you are using, the size of your transaction or relationship and, frankly, your level of sophistication about what you should be charged. Online brokers are now offering among the lowest commission rates in the industry, but that is not the end of the story there either; see the discussion below.
2. Execution. When you are purchasing individual stocks and bonds, there is often a "spread" involved; the difference between what you will pay to purchase the investment and what you will receive if you sell the investment. This spread is another cost to you in executing a transaction - like a commission - and yet is in addition to a commission.
   
   Recently a client held an investment in an online brokerage account at a reported value of $97 ﾽ. When the client ordered a sale of the investment, the commission rate was low but the client was offered only $93. In checking with other brokers, they were able to conduct the transaction at $97 ﾽ. Execution was the difference in that case. It is a relatively "hidden" cost to those who are not trained to look for it.
3. Principal Transactions. Frequently individual bonds, and occasionally stocks, are purchased from you or sold to you by a broker on a principal basis. In these transactions, you do not pay a commission - they appear to be "free". But "principal" means that the party on the other side of the transaction from you is the brokerage firm itself instead of another investor. In other words, the broker is buying from or selling to you for their own account for the express purpose of profiting on the deal. It takes a great deal of research and savvy on the investor's part to know if they are getting a fair price in a principal transaction.
4. Loads. Mutual funds are frequently sold with so-called "loads". These are amounts that are deducted from your investment at the time it is made; in other words, you invest $1, but the day after you make your investment it is only worth 95 cents. The difference is the "load", or essentially the commission that was paid to the broker who sold you the mutual fund.
5. Deferred Sales Charges (or Redemption Fees). These costs are common with mutual funds or annuities. These are fees you must pay to the fund or annuity company if you decide to move your investment from them before a stated period of time. These fees arise from the fact that the company has paid the broker who sold you the investment a commission based upon the presumption that it will make money off of you for a period of time. If you leave early, they need to charge you a fee to recoup the revenue they will lose because they are already out-of-pocket to the broker for the commission.
6. Trailer fees. Mutual fund and annuity companies often pay trailer fees to brokers for recommending their fund or annuity investments to you. In some cases these fees are paid in addition to the other sales charges mentioned above. In other cases they are paid in lieu of those charges so the broker can provide you a so-called "no-load" fund and still get paid. In all cases the return that is reported to you is net of these fees, so you will not notice them unless you know they are there and look carefully.
   
   Money markets are a special situation. Funds in your investment account that are invested in money markets often earn very low, below market interest rates. In many cases your broker is reaping a significant percentage of your balance in a money market fund as a trailer fee. This may not amount to much in dollars in your case, but when multiplied by a number of clients the practice can be a substantial income item for your broker.
7. Fees. Many financial advisers charge fees these days. Sometimes these fees are in lieu of the other charges discussed above and sometimes they are not. There is a critical and yet confusing and misunderstood distinction between advisers that charge fees that requires clarification:
1. Fee-Only. The term "Fee-Only" is a registered trademark of the National Association of Personal Financial Advisers (NAPFA). In order to become a member of NAPFA and legally use this term to describe his or her practice, a financial adviser must charge clients only a fee for their services and may not accept any other compensation, including those mentioned above, as a result of his or her recommendations. NAPFA believes this compensation structure ensures that the clients' interests are always placed first and that recommendations given are completely objective. Visit NAPFA's web site at www.napfa.org for more information.
2. Fee-based. Because of the success of the fee-only approach in creating an objective, client advocacy relationship between an adviser and a client, many advisers not qualifying to use the term "Fee-Only" have started to charge fees to create the perception that they are serving clients in the same way. But so-called "fee-based" advisers are very different from "fee-only" advisers. Fee-based advisers typically charge fees in addition to accepting one or more of the methods of additional compensation discussed above. So how much are you really paying for your financial services? Chances are good that it is a lot more than you think! How can you know for sure? Either become an expert yourself in these intricacies or hire one of a rare breed of financial adviser - a Personal Financial Advocate  to represent you in your financial affairs and know these things for you so that you can properly factor them into your decisions.

* * * * * * * *

Thomas W. Batterman, a Certified Trust and Financial Adviser and the Senior Personal Financial Advocate for Vigil Trust & Financial Advocacy, Wausau, Wis., has 17 years of experience in the financial advisory field. He is a licensed attorney and is a member of the National Association of Personal Financial Advisors. His firm, Vigil Trust & Financial Advocacy, was started in 1988 as the State of Wisconsin's only fee-only registered investment adviser with full corporate trust capabilities and is a founding member of the Association of Independent Trust Companies.