Category Archives: fees

Passive Investing: The Choice of More Investors

Posted on November 5, 2009 | Leave a comment

Passive generally refers to investing in index mutual funds or exchange traded funds rather than active managed mutual funds.  The rivalry between the approaches has raged for years, but evidence is mounting for passive funds.  And investors are listening.

In 1999, $12 billion of exchange traded funds (ETFs) were issued.  Net issuance of ETF shares rose to $177 billion in 2008.  From year end 1998 through 2008 ETFs issued $661 billion in new shares.   The rise in demand came from both institutional and individual investors, according to the Investment Company Fact Book. (www.ici.org) 

Why the passive approach?

Passive investment vehicles include index mutual funds and exchange traded funds (ETFs).  Both track the performance of a basket of securities included in an index.

For instance, the Russell 3000 Index measures the performance of the broad U.S. equity market.  The Ishares Russell 3000 Fund (IWV) is an exchange traded fund that holds a representative sampling of the securities in the Russell 3000 index.  The sample has an investment profile similar to the index, and may or may not include all of the securities that are included in the index.

As of 10/31/2009 the Russell 3000 index included 2,968 securities.  The Russell 3000 Fund (IWV) held 2,964 of the securities included in the Russell 3000 index. (source:Morningstar)

An index does not invest in the securities, it simply tracks their performance.  Therefore there are no fees included in the index returns. 

Funds, however, invest in the securities and the performance is reduced by transaction costs and other ongoing costs, such as management fees and other fund expenses. The net annual expenses, ongoing costs, for the Russell 3000 Fund are .20% (1/5 of 1%), according to the 2009 annual report.

A fundamental reason investors choose a passive approach is because they are aware that the majority of actively managed mutual funds are not able to out perform their benchmark index over an extended period of time.  The high expenses associated with active management such as transaction and ongoing costs,  reduces the fund’s performance by an average of about 1.5% per year, according to http://www.icifactbook.org/fb_sec5.html

That means if the index posts an 8% return, the average active managed fund would have to achieve a 9.5% return in order to net 8% after costs. If the fund’s returns are less than 9.5%,  it under performs the index. 

Relatively efficient pricing of stocks and bonds along with costs associated with active management makes beating the index a daunting task.  According to a Standard and Poors study, Indices Versus Active Funds Scorecard, Year End 2008, less than 50% of active managers beat their indices over a 5-year period.

An analysis of two – five-year periods of performance; 2004 to 2008 and 1999 to 2003 revealed the following for…

…Large-Cap Active Managed Funds: 72% under performed their S&P 500 index in 2003 to 2008 period, 53 % under performed in 1999 to 2003. 

…Mid-Cap Active Managed Funds: 79% under performed the S&P MidCap 400 benchmark in 2004 to 2008 period, and 91% under performed in 1999 to 2003.

…Small-Cap Active Managed Funds: 86% under performed the S&P SmallCap 600 benchmark in the 2004 to 2008 period, 69% under performed in 1999 to 2003.

According to the study, one consistent investment myth has been that active managers have an advantage in bear markets due to the ability to move quickly into cash or defensive securities.  The study analyzed the performance of active managers during the past two bear markets, 2008 and 2000-2002.   The report illustrated over 50% of the active Large-Cap funds under performed their benchmark, over 70% of the Mid-Cap and Small-Cap funds under performed their respective indices. 

The under performance of active managed international equities and bond funds were similar to U.S.  stock funds. 

To view this study you may have to copy and paste this url  http://www2.standardandpoors.com/spf/pdf/index/SPIVA_Rerpot_Year-End_2008 

In conclusion

Exchange Traded Funds and Index Funds offer low cost ownership of both stocks and bonds.  The high cost of active management is one stumbling block that is difficult to overcome for most active managed funds.  Even in bear markets, the majority of active managers fail to beat their benchmark index.

Golden Hills Financial Group is an independent investment advisory firm utilizing exchange traded funds and index funds in portfolio construction.

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How Do Investment Advisors and Stockbrokers Get Paid? Part2

Posted on April 9, 2008 | 2 Comments

I’ll continue to refer to the SEC’s website to continue our discussion of fees.

The Securities and Exchange Commission (SEC) lists how investment advisors get paid.  http://www.sec.gov/investor/pubs/invadvisers.htm

Q:  How do investment advisers get paid?

A:  Before you hire any financial professional-whether it’s a stockbroker, a financial planner, or an investment adviser-you should always find out and make sure you understand how that person gets paid. Investment advisers generally are paid in any of the following ways:

  • A percentage of the value of the assets they manage for you;
  • An hourly fee for the time they spend working for you;
  • A fixed fee;
  • A commission on the securities they sell; or
  • Some combination of the above.

In Part 1 of this article I talked in more detail about a percentage of the value of the assets they manage for you.  Now I will describe the remaining ways investors pay their investment advisers.

An hourly fee for the time they spend working for you

This is pretty straightforward.  An advisor may choose to charge for services by the hour.  They charge an hourly rate for time spent on communication through phone, personal contact, email, and managing your assets.  I find this fee schedule is more common with advisors who provide both financial planning and investment advisory services.    In some instances, there may be an hourly rate for the advisor’s time and a lesser rate for the time an administrative person works on a client’s account.

A fixed fee:

An advisor may assess the services required and estimate the time required to complete the work.  They will set a fixed fee.  The fee may be split, a portion up front with the remaining at the completion of their work, all up front, or all at completion.  Fixed fee for financial planning is quite common, with $2,000-$5,000 being a common range.  Of course, the complexity of your situation will determine this rate.  If the financial planner is going to manage your investments, they may charge for that service using one of the fee schedules above.

A commission on the securities they sell:

Each transaction, the purchase or sale of a stock, generates a sales charge called a commission.  The commission is calculated as a percentage of the transaction or as a flat fee.  These charges change from brokerage firm to brokerage firm, and even within the same brokerage firm.   A firm may have commission rates based on the size of the transaction and client’s portfolio size.

There are significant fee differences between discount brokerage and full-service brokerage commissions.

Full-service Broker:  If you rely on a broker to recommend stocks to buy and sell and to make the trade, commission charged for each transaction may start at $35 and go higher.   Let’s say your broker recommends you sell $1,000 of ABC company and buy $1,000 of XYZ company.  Let’s also assume the commission is $40 per trade.  The commission charged to your account will be $80.  $40 to sell ABC and $40 to buy XYZ.  Commissions amount to 8% (80/1000).  The stock has to rise 8% before you begin making any money.

Discount Broker: If you decide what stocks you want to buy and sell, you can use a discount broker.  Online trades range from $4 – $20 and you either make the trade yourself (cheapest) or call the broker to make the trade.   If we use the same example from above except use a $10 commission, our cost is $20 or 2% of the stock value.  You keep 6% in your account.

Sales Charge (Load) on Purchases

A sales load is like a commission investors pay when they purchase a security through a broker.  Mutual funds that use brokers to sell their shares typically compensate them by imposing a fee on investors, known as a “sales load” (or “sales charge (load)”), which is paid to the selling brokers.

There are two general types of sales loads-a front-end sales load investors pay when they purchase fund shares and a back-end or deferred sales load investors pay when they redeem their shares.

Front-end Sales Charge (Load) on Purchases

The Front-end Sales Charge (Load) on Purchases is the amount investors pay when they purchase fund shares. The key point to keep in mind about a front-end sales load is it reduces the amount available to purchase fund shares.

Example: if an investor writes a $10,000 check to purchase mutual fund shares, and the fund has a 5% front-end sales load, the total amount of the sales load will be $500. The $500 sales load is first deducted from the $10,000 check (and typically paid to a selling broker), and assuming no other front-end fees, the remaining $9,500 is used to purchase fund shares for the investor.

Deferred Sales Charge (Load)

The Deferred Sales Charge (Back-end Load) investors pay when they redeem fund shares (that is, sell their shares back to the fund).

Example: if an investor invests $10,000 in a fund with a 5% back-end sales load, and if there are no other “purchase fees,” the entire $10,000 will be used to purchase fund shares, and the 5% sales load is not deducted until the investor redeems his or her shares, at which point the fee is deducted from the amount redeemed.  Back-end loads may decline over time.  A 5% charge may decrease by 1% each year.  Example: year 1 a 5% fee is paid if an investor sells the fund, year 2, 4%; year 3, 3%….. year 6, 0%.

A fund with a contingent deferred sales load typically will also have an annual 12b-1 fee, a portion up to .25% is typically paid to the broker.

To learn more about mutual fund expenses and fees go to  http://www.sec.gov/answers/mffees.htm#distribution

Some combinations of the above.

Some advisors charge a percentage of the assets value and receive commissions.

There are advisors who charge an hourly fee or a flat fee for certain services plus a percentage of the portfolio value for managing your investments.

There are certainly other combinations, so be sure to read the agreement or contract and then ask the advisor to explain “how do you get paid?”.

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How Do Investment Advisors and Stockbrokers Get Paid? Part 1

Posted on April 6, 2008 | Leave a comment

Investment advisors, brokers, investment managers, and financial advisors do get paid.  It sounds like a silly statement.  Of course they get paid.  They’re in business to earn a living.  The funny thing is most people don’t know how their advisor is getting paid nor do they know how much they are paying him/her.  In a recent conversation, a friend who has been relying on a broker to help him manage his investments, blurted out, “I don’t pay my advisor anything”.  He’s a bright guy, so as soon as his words made it back to his ears he looked like a deer caught in the headlights…. stunned and perplexed.  Today I met with a woman who had no clue she had just signed on with an investment advisor who was charging her 1.5% annually to manage a portfolio of mutual funds.  In addition, a clause in the agreement stated if she left in the first 12 months the firm would charge her 2 quarters of investment fees or $1,425.  The point is, you as an investor have the responsibility to read the agreement and point-blank ask your advisor how they get paid.  Most advisors are happy to share that information with you.  If they’re not, it’s better you find someone who is.  Open communication is necessary to have a good long term relationship. 

How do investment advisers get paid?  This is the Securities and Exchange’s (SEC’s) answer found at  http://www.sec.gov/investor/pubs/invadvisers.htm

A:  Before you hire any financial professional—whether it’s a stockbroker, a financial planner, or an investment adviser—you should always find out and make sure you understand how that person gets paid. Investment advisers generally are paid in any of the following ways:

  • A percentage of the value of the assets they manage for you;
  • An hourly fee for the time they spend working for you;
  • A fixed fee;
  • A commission on the securities they sell; or
  • Some combination of the above.

I’ll describe each fee structure.   They are general descriptions so expect variations.   

A percentage of the value of the assets they manage for you; 

Let’s say the advisor states they will charge 1% of the value of the assets.  That means if you have a $500,000 portfolio your estimated fees will be $5,000 per year ($500,000 x .01).  It’s an estimate because the fee is charged quarterly based on the value of your portfolio during or at the end of each quarter.   Let’s assume the portfolio value doesn’t change throughout the year.  Fees may be charged ’in arrears’ or ‘in advance’.   They will be calculated based on the value of the portfolio on the last day of the quarter or on the average value of the portfolio during the quarter.   One quarter of the $5,000 annual fee, $1,250, will be the assets under management fee for the quarter.  This fee is generally withdrawn directly from the account, unless you and the advisor agree to another payment option, e.g. check.  The advisor will send you a statement showing the quarterly fees that are being withdrawn.  The advisor may also charge a fee for setting up the account or a fee may be charged if you discontinue using the advisor, like the 2 quarters of fees assessed in the above example.   

The assets under management fee is to compensate the advisor for managing the portfolio.  The advisor will work with you to determine the correct asset allocation (we’ll discuss that term in another commentary) and make buy and sell decisions or recommend securities to buy and sell.  In addition, the advisor will provide quarterly and annual reports that show the retuns compared to appropriate benchmarks.  For instance, if your portfolio is 50% U.S. large company stocks and 50% intermediate term bonds, the report will show the quarterly return of the stock portfolio and the bond portfolio along with a U.S. large company index such as the Russell 1000 Index and the U.S. bond index such as the Lehman Aggregate Bond Index.   By relating the portfolio returns with the index returns an investor can determine whether their advisor is doing a good job of managing their investments.  If the portfolio consistently posts returns less than the benchmarks, meet with your advisor to find out why and if the answer isn’t satisfactory find a new one. 

You will often see the words “fee-only” advisor.  This means the advisor receives compensation exclusively through advisory fees.  They are not paid commissions.  The fee may be as a percentage of assets, hourly rate , or fixed rate. 

A note about me:  I am a registered investment advisor in Colorado.  I receive my compensation from a percent of the value of the assets.  Other rules may apply in other states.  This description is meant to give a basic understanding of how fees are charged.  You may find variations due to your state’s rules or advisors’ business models. Variations might be monthly fee calculations, rather than quarterly,  a higher percentage charged when a minimum return is achieved and a lesser fee when the portfolio return is below the minimum.  Read the agreement and ask the question, “how to you get paid?”   

Part 2 of this topic explains the other types of fees.

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Investment Management Coach Blog Launch

Posted on March 28, 2008 | 4 Comments

Hi, I’m Rita Janaky, an investment management coach located in Colorado Springs, Colorado. I work with intelligent women who want to take control of their financial futures. They are typically women who either earned it, inherited it or received it through divorce, and found themselves suddenly facing important investment decisions. I am not a financial planner – I am an investment manager.  And, I consult with people who are looking to buy a business or sell their current business. 

Why do I do this work? Because I enjoy helping women remove stress from their lives by showing them how to make financial decisions that are aligned with their values or beliefs and ultimately helps them meet their goals. Basically, I want them to feel comfortable with the information so they can make more informed choices.

I have been an advisor since 2001.  In February 2004, I started Golden Hills Financial Group, LLC, a Colorado registered investment advisory firm.  This is an independent fee-only advisory firm. 

Portfolios we create for clients can be moved without disrupting the portfolio because the securities we buy are not proprietary.  For instance, if an advisor represents a firm whose securities are sold only through their advisor network, when a client becomes dissatisfied or heirs want to use a different advisor, the assets must either be sold, creating potentially large cap gains tax liabilities or an advisor within that same network must be utilized.    If our clients or their heirs elect to move, their entire portfolio can be transferred to another advisor with no penalty.

We believe that the markets are generally quite efficient.  That means we rely on exchange-traded funds, index funds, and low cost mutual funds when building client portfolios.  These are low-cost, tax efficient securities that keep more of our clients money working for them.

I am a Licensed International Financial Analyst, hold an M.B.A. and a B.S. in Business Administration, emphasizing finance with a minor in economics.  I have taught finance and investments at 2 universities, for the American Association of Individual Investors (AAII) Colorado Chapters, as well as public seminars.  

The goal of this blog is to educate.    In particular, to educate women who want to become better investment managers or those women who want to learn more about ’how to sell their business’ or ‘how to buy a new business’.

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Posted in asset allocation, buying a business, fees, investments, life changing events, mergers and acquisitions, risk tolerance, selling a business

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