How Much Are You Paying for Investing Fees?

When it comes to managing investments, many people are simply unaware of what they're paying. We are often tempted to turn a blind eye to fees, especially if we're uncertain about how things work or even what questions we should be asking.

However, whether you're happy to pay for the services of a trusted adviser or unhappy with your situation, you should certainly know about how fees work and what they are. As I always say, knowledge is power!

Account Fees

The most straightforward fee you may encounter is the annual asset management fee. It's charged directly out of the account, often expressed as a fixed percentage of assets under managemen and most likely charged on a quarterly basis. For example, your adviser might charge 2% per year.

However, the annual management fee is not a given. Some advisers charge all clients a flat annual fee. Others work only on a commission basis, in which a dollar amount is charged per transaction. Some advisers will set up two separate accounts, one being a fee-based account and the other a commission-based account.

For example, if you want an actively managed, diversified portfolio, you may find that most advisers will quote a flat fee. This is because these accounts require consistent re-examination, careful trading, rebalancing, tax harvesting, etc. If you find there have been absolutely no changes to your fee-based account in the last two or three years, you should probably not be paying an annual asset management fee.

Mutual Fund Fees

If your account is invested in mutual funds, you may also be subject to two additional fees. The mutual fund's annual expense ratio is the most commonly known, and it covers the mutual fund's fixed and ongoing expenses, such as portfolio manager salaries, customer service reps and the printing costs of prospectuses and marketing materials.

An easy way to learn about expense ratios is to visit Morningstar.com, where you can type any fund's name or symbol into the search box and find basic information, performance numbers and a fee report. It's a great, easy-to-use tool that will really help you learn about your investments!

Once you know a given fund's expense ratio, you need to take into account several variables before determining whether it's reasonable. Actively managed mutual funds typically carry higher fees than index funds, and, generally speaking, international or emerging market funds are more expensive than your average Standard & Poor's 500-stock index fund.

Mutual funds also charge fees for brokerage commissions and trading expenses incurred. Of course, a mutual fund's trading fee structure is likely far lower than anything an individual could command, but more trading still equals more fees. In order to find out about these ongoing variable expenses, you have to look at the fund's annual Statement of Additional Information (SAI). This information is not required to be mailed to you like the fund's prospectus and can be difficult to quantify, even when using information available online.

Getting What You Pay For

As you can see, the possible fees can add up quickly. For example, suppose you are paying a 2% asset management fee and have a basket of mutual funds with an average of 1% in expense ratios and 1% in trading fees. In this case, your break-even requirements in terms of performance are suddenly a lot higher than you may have anticipated.

Now, you may think that as long as returns are meeting your expectations, total costs don't really matter. I wish it was that easy, but unfortunately relying on high returns is not enough. Most importantly, you need to consider how much risk you're taking on and whether the asset management fee and portfolio strategy make sense. If you're paying for active management, you should be getting it, and any portfolio should be grounded in an understandable investment philosophy. Finally, remember that you pay fees both in good markets and in bad, so trying to establish some downside protection and risk management strategies are important issues relevant to both performance and cost.

It may sound daunting, but don't be reluctant to ask about this! Fees can eat away at your portfolio's value over the long run, so it's important that you understand them. A good adviser will always talk to you about his or her management fees and mutual fund expense ratios and won't be afraid to investigate lower-cost alternatives. Indeed, there are many ways to build cost efficient portfolios; for example, instead of building a diversified portfolio consisting only of mutual funds, you might add a mix of mutual funds, exchange-traded funds and individual stocks.

In the end, of course, proper asset management comes down to the big picture. It's about building the portfolio that is right for you, which should take into account not just cost, but the risk you're willing to take on, whether you're seeking active or passive management and whether there are other services that you receive in exchange for the fees you pay.

It's critical that you understand and are comfortable with your management plan, and the best way to ensure that is through education. With this primer on fees and fee structures, you have taken the first step in understanding some of the important details about the management of your accounts, which gives you the power to steer your portfolio management in the direction that is right for you.

Read the original version of this article on www.bradpine.com.

Bradford Pine is a wealth adviser and president of the Garden City, NY-based Bradford Pine Wealth Group. He assists individuals to create wealth, simplify their lives and plan for retirement.

Anna B. Wroblewska contributed to this column.