We all know the mantra: be smart with your money, save for the future and spend wisely. Yet many leave high school/university without a clue on how to invest and truly work towards building wealth. Stocks and finance require extensive study, particularly when it comes to how fees work. Financial advisors do not work for free, and their compensation structures vary. To be sure you as an investor can maximize your returns, it is critical that you understand the costs of investing.
A fee based investing account is where the advisors compensations is a percentage of your invested assets. This means that if you invest $10,000 with your advisor whose fee is one per cent, he will receive $100, regardless of what he accomplishes for you on the market. Sounds terrible right? Well there is another side to it. By tying your advisor’s compensations to the total accumulation of profits, the advisor has greater incentive the advisor to increase your total assets.
This structure forces the advisor to be committed to your account, although your fees will be higher, so could your returns. Now you can invest knowing your interests are aligned with that of your advisor, ultimately building a deeper relationship with your advisor.
A commission-based investment account is where the advisor’s compensation is based on charging front-ended or back-ended fees. A front-end charge pays the advisor a commission upfront, which comes directly out of your principal investment. While there are no fees to redeem your money, the front-end charged by the advisor up front can range from 1% – 5%. A back-end charge pays the advisor a commission up to 5%, which is funded by the fund company, so it doesn’t come out of your principal. However, a back-ended investment comes with deferred sales charges (DSC), if you were to redeem before the maturity period, usually 6 years. A lot can change within six years and having your money tied up for that long may not be beneficial to you. While the practise of charging back-end fees is declining, there are still advisors who will operate this way.
The concern here is that these advisors may operate a more transactional business, as the fees are earned up front, and will spend more time on bringing in new business as opposed to managing a client’s portfolio. When investing with a commission-based advisor, it’s important to ask a lot of questions so you understand the fees involved and to ensure that working with this type of advisor is in your best interest.
What is the Alternative?
Many may now think: “I might as well manage my own money?” While this may save you some money, it may be costly in the long term, as working with a financial advisor has its benefits. Not only will they provide investment advice, but will also assist you in meeting your financial goals, ensuring your investments are tax efficient, and will provide you with knowledge that you may not know. Financial Advisors are professionals that can greatly increase your net worth, and studies have shown that households working with a financial advisor tend to have more money saved up at retirement.
Before you work with a financial advisor, understand how their fees work, ask questions and make sure you are comfortable with them, as you could be working with them for many years. There is nothing wrong with pay investment fees, just be sure to understand the costs that come with it.