Gazelles are the animal kingdom’s version of fast-food on the African Savannah. Their nickname is “McDonalds” because of the black, M-shape markings on the back of their rumps and because all predators gladly eat gazelles. Even smaller predators and omnivores, like eagles and baboons will eat young gazelles if they can catch them. This grazing animal supports an entire ecosystem of predators in the biodiverse African grasslands.
The money you invest plays the role of the gazelle in the retail, financial investment world. An entire financial services ecosystem feeds off of your money. Whether you know it or not, you are in a struggle over who ultimately gets possession of the dollars you invest.
Wall Street uses various strategies to hunt and capture your money herd.
Predator fee strategy #1 is the friendly local investment advisor: Financial advisors are typically paid via the sales commissions and other fees charged by the sale or purchase of investments. In addition to fees for single investments like stocks, they charge fees for the purchase or sale of many mutual funds. For example, some mutual funds dictate a front-load fee that goes to the salesman. These are the commissions you pay when you purchase a mutual fund. Or, they might charge a back-load fee, which is a charge when you redeem the mutual fund.
Predator fee strategy #2 is a legal document called the prospectus: This is a long legalese document they seem to take pleasure in making as difficult as possible to read. In this document, they hide the fees that you are going to pay your advisor. Fees hidden in the prospectus include the sales commission fees that are described above, plus others. You may also pay a fee called a 12(b)1 fee, which is an advertising fee.
Predator fee strategy #3 is the expense ratio: This is how much the advisor will charge you annually to manage your funds and investments. This charge is legitimate, but only to a certain point. If this fee is too high, it will kill or significantly retard your profit growth.
Your goal should be to avoid fees and keep your herd of dollars reproducing in your own account—where they belong. The idea here is to cut-out the advisors and keep their commissions in your own accounts.
Here are 4 easy steps I recommend to avoid Wall Street’s fee predators:
#1: Avoid actively managed funds, where an advisor is involved in actively buying and selling investments while trying to make a profit. These funds can charge anywhere from one to over two and one-half percent. The fees are needed to pay the army of stock analysts who are searching for stocks that represent a good buy in an attempt to “beat the market averages” (beat the averages as reflected by the various market indexes).
#2: Realize the hidden impact of fees: The fees don’t seem very high at first glance, so let’s do some basic math to show how fees can really impact you. Say, for example, a fund charges an expense ratio of one percent. That doesn’t seem like much, but $100,000 x 1% = $1,000 charge on your investments annually—whether you make a dime or not. If your fund goes up in a given year, they take the new, higher amount and charge you the same one percent. Over the long haul, they can knock your entire portfolio down by 20 to 30% of the total balance—depending upon the size of the fees being charged and how long you have been paying the fees.
#3: Use low cost index funds: The fees for index funds range from zero in large brokerage firms to .50 percent. A mix of index funds represent the best buy for the lowest fees. A mix of stock index funds and index bond funds with low fees represent the best and safest bargains available for the average investor.
#4: Learn the simple concepts underlying portfolio management rather than paying an advisor one percent or more to do this job: The concepts of portfolio management are very easy to learn and there are lots of resources available to help you. A book can easily do the job and provide specific actions to accomplish this goal. Really, it is not the hard!
Fees are a very serious matter for informed investors and are one of the main factors that make the difference between investing profitably or creating an investment flop. Learn to manage your own portfolio and use index funds to save big and grow your herd of money dollars in your own account, where they belong.
~ Larry Faulkner