How Much Are You Really Being Charged By Your Financial Advisor?

This is a guest post from The Intelligent Speculator.  Please visit his blog and consider subscribing to his RSS Feed.

Recent big stories such as the massive Madoff fraud have brought to light a concept already known to most who work in the finance industry but is mostly unknown to outsiders; the amount of fees they are truly paying. It has been covered in the past few weeks but it’s not a new concept at all. I’ll start with the most obvious choice, the somewhat wealthy investor that is using a financial advisor and wishes to invest in a hedge fund. Now as we all know, these funds often charge very high fees, typically under a structure such as 1/20 which means you are paying 1% of the value of your investment annually as well as paying 20% of the performance by the manager.

Think that is expensive? Absolutely. But the problem is that most investors are paying even more because they do not have direct access to the hedge fund so instead they go through funds of funds, basically an extra step to invest in the funs with guess what extra fees. And generally your advisor who suggested going into the fund of funds also took a layer of fees… see where I’m going with this?

And if you think that this only applies to those investing in hedge funds, you are wrong. I will give you one example. What is the different between an ETF such as SPY and a mutual fund that tracks the S&P500 index? Not much actually except for the fact that the mutual fund charges up to 5-6 times more in fees. So why would your financial advisor buy you these funds instead of the ETF’s? Because he is one of the recipient of those fees as is the seller of the fund, the managers, etc. And believe me, over an investment life, paying .20% or 1.20% makes an incredible difference.

The sad part of course is that this information rarely makes it to any kind of mainstream media. Why? Because those with money and power, the brokers and every one involved in the selling of such investments does not have much to gain from it. For a financial advisor to buy you an ETF will basically generate almost no revenue (except for the up-front commission that is now generally under 20$ per trade). Compare that to selling a mutual fund and getting a recurring stream of income every month of every year until it is sold (which in theory could be decades away)… no wonder you will rarely meet an advisor that will recommend that you buy an ETF….

What are your thoughts on the subject? How could this problem be resolved to give better incentives in order to have financial advisors’ pay be according to our return, not according to the products they sell us? Maybe it is idealistic to hope for a perfect solution and I would be the last guy to recommend not using a financial advisor…but there’s gotta be a better option…right?