The heavy burden of recurring investment feesThe heavy burden of recurring investment fees

Recurring fees, such as asset management fees, 12b-1 marketing fees, and advisory/asset custody fees are charged periodically, as a percent of your investment assets. Recurring investment costs can significantly impact the long-term value of your retained investment portfolio assets.

The relative cost-efficiency of your investment portfolio in the past has greatly influenced whether you have more or fewer assets today. The investment funds that you have retained in your portfolio are net of any annually recurring investment costs and any investment taxes that you have already paid. If your annually recurring investment costs have been excessive in the past, then it is likely that the growth of your personal investment portfolio has already been stunted very dramatically.

It may seem odd to need to state this, but your currently retained investment assets are YOUR assets. You should only compensate advisors for delivering superior investment management results compared to what you could have achieved with a very low cost passive index fund investment strategy. Sadly, this is not how the game works.

If you permit it, the financial services industry will assess various percentages for their services against your entire retained investment portfolio assets, through multiple types of recurring charges each and every year. Whether the value of your assets increases or declines in the securities markets has little influence on these fee arrangements. By billing as a percent of your assets, the industry gets paid as long as you still have assets.

The simple fact that you do have some investment portfolio assets enables the securities industry to assess annual investment fees. As long as the industry’s annual fees are less than 100% of your investment returns, it is at least possible for the nominal value of your investment funds to increase. (Whether the non-inflationary or real dollar value of your assets will increase, after fees, taxes, and inflation are taken into account, is an additional consideration.)

Obviously, any rational investor would rebel at confiscatory charges that approach 100% of their annual returns – with or without inflation. However, the average investor typically pays in total between 2% and 3% of his portfolio assets in total investment expenses each and every year. Because total investment fees charged across the industry keep growing, it seems that the average investor pays these recurring fees willingly, if not either naively or grudgingly. 

Even though typical annually recurring investment fees are less than average historical returns, 2% to 3% of portfolio assets yearly for total investment expenses will consume a very substantial part of gross market returns. In effect, in an average year the industry’s investment charges allow individual investors' net portfolio values to appreciate modestly. Your gross returns are trimmed significantly by excessive fees. Typically, investors lose between 1/3 and 2/3 of their gross investment returns every year. These fees hobble, but do not fatally wound all these golden retail investor geese.

By charging fees as a percent of your assets, the investment industry can make their recurring fees seem small – like they are “just a few” percent. Furthermore, by charging fees against your assets the industry can still bill you every year, even if the value of your investment portfolio declines. An alternative client billing method would be to charge a percentage of your actual investment returns. Tying investment management performance to investment returns would seem to be a compensation mechanism that would be more closely connected to serving your investment growth interests. If your investment managers improve upon your risk-adjusted portfolio performance above an appropriate passive index fund benchmark, then they might actually earn their fees. 

However, if investment managers were to charge against your returns and not your assets, then the percentage of your returns would have to be a huge proportion of your annual returns. In fact, to equal the fees they charge as “just a few percent” against your total asset portfolio, they would have to extract in the range of 1/3 to 2/3 of your annual portfolio returns every year. Moreover, if you did not have a return in a particular year, then the industry would not get paid – just like you did not get paid by the markets!

Of course, you do not have to worry about paying a percentage of your returns, because the Investment Advisers Act of 1940 specifically prohibits taking a percent of a client’s returns, unless the client meets certain qualifications, that is, the client is a qualified investor who is already relatively wealthy and supposedly more sophisticated. Instead, the Investment Advisers Act of 1940 allows only for charging some percentage of assets each year for investment management services. On its surface, this might at first seem like consumer protection, because investment managers cannot directly take away the investment returns of naïve investors.

The direct investment asset management fees of advisors typically are in the .75% to 1.5% (or higher) range, but these are not the only fees that individual investors pay. When individual investors pay asset management fees, they expect that the advisor will actually earn their fees by delivering better performance than they could have with a passive, very low cost index fund investment strategy that targeted a market return.

Therefore, advisors to retail investors rarely suggest adopting a low cost passive index fund strategy. Instead, they put their clients into actively managed mutual funds with much higher fund management expenses and higher, more costly investment turnover. Alternatively, they might frequently buy and sell ETFs and incur substantial transactions fees. Furthermore, many investors will pay additional investment sales loads for the privilege of riding this costly investment merry-go-round.

The total fees extracted through percent of assets fees and sales loads is huge. In total, the average investor ends up paying between 2% and 3% of their portfolio assets every year, and many pay even higher percentages. The average investor paying these fees is likely to end up with less than they would have had, if they had adopted a very low cost index fund investment strategy. 

Starting today, you should focus on correcting any cost-inefficiencies associated with your current and future investment cost practices. You can only do something about investment costs going forward. Stop giving your assets away through excessive and unwarranted recurring investment fees and sales loads.