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How to Combat the Lure of 'Free' Financial Advice

"There's no such thing as a free lunch." Most readers have probably heard this saying, but where does it come from? Some say that in the nineteenth and early twentieth centuries, saloons would offer their patrons a free lunch in order to drum up business. At many places, patrons were required to buy a drink before taking part in the free lunch. Additionally, many of the foods served were incredibly high in salt. The saloons would often serve salted cheeses, ham, crackers, pretzels and breads. This food would cause the diner to become thirsty and buy more drinks. The drinks would increase appetite and the cycle continued—pretty devious.

Even today, some bars engage in the free lunch promotion; of course, you may have to purchase a few full price drinks to qualify. So, two drinks and a cheeseburger for a quick lunch. Maybe that's a good deal, but it definitely has a cost. Still, this is not world-changing knowledge; most people know that, logically, nothing is truly free. (For related reading, see: How to Distinguish Advisors From Salespeople.)

The Price That Comes With 'Free'

Yet, even though we know logically that nothing is free, we often do not make logical decisions when buying products and services, including investments. This is why the word free is so powerful in marketing—the term implies all gain with no risk or cost. The term elicits a greed response and avoids a fearful one. However, while a free lunch might actually cost you $10 or so, free financial advice can be much more expensive.

Since investment charges are often hidden and difficult to decipher, many investors think they are paying nothing in fees. Others have an idea they are paying fees but have no idea what those fees are. The average person with a $120,000 account paid $873 in ongoing mutual fund expenses. This $873 did not include sales charges, account fees, transaction fees and other charges. Once you add in the effect of all of these fees, as well as possible soft dollar arrangements, mutual funds held in IRAs can cost investors more than 3% a year. In a taxable brokerage account, that fee can rise to more than 4%. (For related reading, see: 5 Investment Mistakes You Might Be Making.)

Unfortunately, though the expense ratio and sales charges are visible, many investors still do not know the amount of those fees. Other expenses, such as transaction charges, are not required to be disclosed. So, even if an investor wanted to calculate a mutual fund’s transaction fees, he or she would be hard pressed to do so.

The fees in mutual funds cause two problems. The direct problem is anything that is paid in investment expenses will come out of the client’s return. The other problem can be one of service; when investors never see fees, they can become complacent, disengaged and underserved by their advisors.

So, I implore you to think about your investments with a critical eye. Always look for an advisor that discloses what the fees will be. If the advisor says they do not charge for advice, recognize it as a red flag. Do your homework and calculate your fees; the investment in time you spend today could save you a large sum of money over the course of your investment. (For related reading, see: Should You Choose a Fee-Only Financial Advisor?)