Two types of investment fees you must know

Wealth managers charge a fee for their expertise and services rendered. When there is an alignment of interests with the investors they serve, these fees serve as motivation for wealth managers to fulfill their responsibilities to the best of their ability.

Two types of fees

There are two key types of fee charges that investors need to keep a lookout for. Both fee types, when not misused, serve the same purpose of improving investors’ portfolio performance.

• Ongoing Management Charges

These fees are charged annually and are a percentage of the total assets managed. They are also known as advisory fees, wrap fees, ongoing management fees, and more. The typical charge ranges from 1 to 2% per annum.

• Transactional charges

These charges are charged for every transaction made and are a percentage of the assets transacted. They are known as bank fees, sales charge, front-load fees, and more. Typically, the charge ranges from 3 to 5% per transaction for retail investors, and 1 to 2% per transaction for mass affluent investors.

Pros and cons of annual management fees

• Pros

Charging an annual fee means that the wealth manager’s earnings are not dictated by the investment product or how many transactions will be made. Clients can unlock their funds without penalty fees should the wealth manager not serve his/her needs.

This ensures alignment between the wealth manager’s compensation and their responsibility to provide objective advice and guidance towards the fulfillment of investment goals.

Annual fees help to make sure that all portfolio rebalances and asset repositionings are based on the clients’ best interests to serve the clients’ financial aspirations. Wealth managers may also be motivated to ensure regular progress meetings to better serve the client. 

• Cons

The annual fee may still be unable to motivate wealth advisors to continuously look out for ways to improve a client’s portfolio. There are other factors such as the wealth manager’s knowledge of existing and new investments, ability to understand investors’ needs and passion for his job.

In addition, the wealth manager may also be motivated to influence the investor to increase the size of his portfolio through investments which may not be beneficial, as this would allow them to earn more annual fees.

In this regard, it is important to find a trusted and professional wealth manager who will take calculated moves and consistently look for areas of improvement to keep the portfolio in tip top condition.

Pros and cons of transaction charges

• Pros

With every transaction made, investors are able to cash in their profits or loss. In addition, there is a possibility that the overall transaction costs may be lower than the annual fees if there are not a lot of transactions made per year on a fraction, and/or if the bulk of the portfolio does not require any transactions.

• Cons

While illegal, wealth managers may abuse this fee structure to lock in fees by making multiple transactions which may not be in the best interest of the client. This process is also known as churning.

Let us calculate the impact on ROI.

To better illustrate this point, let us compare two simple portfolios. The first portfolio amounts to $100k with a advisory fee at 1% per annum. The second portfolio has a total transacted volume of $100k in a year with a transactional fee of 2% per transaction:

First portfolio:

Consistent 1% charge = $1,000/year (1% of investment) 

Second portfolio:

Each transaction = $2,000 for $100,000 (2% of investment)

10 transactions = $20,000 (20% of investment)

24 transactions = $48,000 (48% of investment)

40 transactions = $80,000 (80% of investment)

Of course, in reality there are many other variations to consider. The total transacted volume may be a small percentage of the overall portfolio, or the investor may wish to do short-term transactions instead of value investing.

Either way, a wealth manager’s job does not stop after selling an investment product.

If the wealth manager does not value add by conducting regular progress meetings or providing well-evaluated recommendations of investment products after the initial sale, it may be more cost effective to pay a sales charge.

Essentially, fees are just one aspect of your investment journey with a wealth manager. Finding someone who you can trust and is completely aligned to help you achieve all that is important to you is the most important. This is how a wealth manager can become your personal CFO to help you reach your life’s aspirations. One way to achieve this is to ensure that his compensation is aligned with your interests.

It’s all about getting someone you trust

All in all, it is important to find someone trustworthy who you can resonate with. Fee transparency is important in managing risk, but there is no simple answer to which is better - a fee-based advisor or a commission-based advisor. The key is to get a wealth manager who can help you achieve what you want, such as an early retirement. Afterall, he/she will be the person managing your hard-earned money while you focus on living life to the fullest.

The responsibility also lies on you, the investor, to do your own due diligence and select a professional advisor. Instead of trusting the advisor blindly, asking questions to understand why certain investments are recommended can help ensure that your best interests are being represented.