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Nickel And Dime'd: 6 Sources Of Costs In Your Portfolio

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With the rise of Vanguard and the discount brokerages, overall costs to asset management have been lowered tremendously.  I think, for the most part, the age of the self-styled Mutual Fund Don Drapers is a thing of the past. 

1. Account Management / Investment Advisor Fees

These can be formulated as a simple flat fee for service or, more generally, as a percent of assets under management (AUM). They range from a straightforward .25% at the low end for a robo-advisor like Betterment to north of 1.0% for a more hands-on advisor.  I actually tried to look up Morgan Stanley’s fees as an example of a more high-end service but after reading several pages on a link ironically titled “Understanding Our Commissions and Fees,“ I still had no idea what their fees were. See for yourself: (https://www.morganstanley.com/wealth-relationshipwithms/commissionsandfees) and compare to Betterment’s explanation (https://www.betterment.com/pricing/).

Some have claimed that this fee structure aligns your financial advisor’s interests with your own, since by growing your account, their fee will grow pro rata. The flip side of the argument is that they get paid even if they are losing you money.

2. Trading Commissions

These are fees that get charged any time a trade is done.  These range from free* at startup Robinhood to $49.99 for no-load mutual funds at TD Ameritrade.  The more established players seem to have a labyrinthine menu of options where you are charged based on the security type, how you place the order and at what stage the lunar cycle is currently.  

3. Expense Ratios

If you purchase a managed instrument such as an ETF or a mutual fund you will then have to pay the good folks who run that fund.  This fee is usually expressed as a percentage that the fund managers take from the fund on an annual basis and can range from .04% to north of 2.0% for some funds from Oppenheimer.  It’s important to note that this fee should always be viewed relative to its fund class.  For instance REIT ETFs will have a much higher expense ratio than an ETF that tracks a large cap stock index.  Maybe the managers have to do more due diligence or more research for these types of funds. Makes sense to a point, but once you get into the realm of active managers, you now have to judge whether the alpha they add is outweighed by the fees, which is no small feat given the degree of noise present in the market.

4. Paying the Spread

When a stock or ETF is trading on a market there are two relevant prices: the bid which is the price at which people are willing to buy the instrument and the ask which is the price at which people are currently selling the security.  In normal markets the ask is greater than the bid meaning that if you were to just sit there buying and selling the same stock you’d be losing a little bit of money on each trade.  The amount of this loss is the distance between the bid and the ask, known as the spread.  This is the fee you pay market participants (not your broker and not your fund manager) for providing liquidity.  Essentially you have to pay a person to be willing to do the trade right now.  I know it’s a bit esoteric and not exactly transparent to the laymen, but accept that this is a legitimate fee within reasonable bounds.  Luckily there are strong market forces to minimize this cost.  Really this is a subject of its own, related to terms like “market microstructure” and “high frequency trading.”  Just know that in today’s markets, for larger stocks and ETFs, it is generally something like a penny.  For niche ETFs and penny stocks, however, it can be many pennies amounting to a significant fee.

5. Sneaky fees

Even more esoteric is the concept of opportunity cost or the cost you are foregoing in some situation.  Take, for instance, Schwab’s new robo-advisor which they advertise as free.  On a side note, and with one or two exceptions THERE IS NOTHING FREE IN FINANCE.  To make money, Schwab collects interest on any cash in your account, cash that would otherwise accrue to you.  

6. Even Sneakier Costs

With the pressure to lower (and lower) costs, expect more of your money to get whisked away in this basket.  This is such a large topic, it deserves its own post so I’ll just give a few quick examples: (a) kickbacks — I mean commissions that brokers are paid by mutual fund to sell them to you;  (b) lending out your stock to short sellers who pay a fee  to “borrow” your stock; and last but not least (c) “selling retail flow”  This is how Robinhood originally planned to make their money, though I am not sure if they were able to make it work and they may have moved on by now.  Remember that every trade involves two people doing the opposite things, who both think they are correct.  The idea here is that retail customers are terrible traders.  They buy things they should be selling and vice versa.  Think of it like a big poker game.  When someone is selling retail flow, they’re asking a pool of sophisticated traders to pay them for the opportunity to play against a table full of suckers.  Offended?  Surprised?  This has been around since I started trading and I still find it kind of hard to swallow. 

The preceding article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.

Posted-In: Personal Finance General

 

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