The Department of Labor recently released its final version of a new rule that will apply to all financial professionals who work with retirement plans and accounts. This rule will automatically elevate these people to the level of a fiduciary, which is someone who is legally required to unconditionally put their client’s best interests ahead of their own in all business dealings. This rule was enacted in an effort to lower the amount of fees and commissions that many planners have been charging their clients, because these fees are eating away at the returns that clients earn in their retirement plans and accounts. What kind of impact could an annual fee of just 1% have on your portfolio? The answer may surprise you.
The 1% question is not just for clients who are paying a money manager a 1% annual retainer for managing their money. Banks, brokerage firms and insurance companies also charge clients a litany of fees for things like account custody, commissions and other transactional fees, margin interest and maintenance fees. Cash value life insurance and annuities also come with mortality and expense fees, subaccount management fees and the cost of any riders that are purchased in either type of product. Of course, all of the institutions and planners who charge these fees will stand behind them, claiming that they are just part of the cost of investing. But these fees can substantially reduce the overall return that investors earn, especially over long periods of time. The following example shows how this works. (For more, see: Are Fees Depleting Your Retirement Savings?)
Bert purchases a $100,000 variable annuity contract with a living benefit rider that will pay him a guaranteed lifetime income at retirement based on a 6% guaranteed rate of growth. His contract charges him a 1% annual mortality and expense fee, 0.5% for the management of the mutual fund subaccounts, 1% for the rider and 0.5% for other miscellaneous expenses. His contract grows by 7% in its first year, but Bert only sees a growth of 4% in that time. If this were to hold true every year, then in 20 years, Bert will have $219,112. If he was not charged those fees, his final balance would come to $386,968.
Another example shows that a 1% difference in return over 20 years for $100,000 comes to $22,019. Although managed money services are never free, some forms of service cost more than others. For example, actively-managed mutual funds often come with either a front or back end sales charge that can run as high as 5%. They also charge annual fees for managing the money in the fund. (For more, see: Mutual Funds: The Costs.)
Exchange-traded funds (ETFs) usually charge much less, with no sales charges and only minimal annual fees that are charged for maintaining the fund. ETFs also do not have annual capital gains distributions that can further erode the returns earned by investors. However, they will generate gains or losses when they are sold which must be reported if the sales take place in a taxable retail account.
Investors need to be aware of how much they are paying in fees and expenses in their investment and retirement accounts. These fees may be justified, but investors need to know what they can expect to end up with after all the smoke has cleared and the fees are paid. If their financial advisor refuses to disclose this information to them, then they need to start shopping for another one. (For more, see: Retirement Savings: How Much is Enough?)