What are Layered Fees
Layered fees are multiple fees an investor pays for the management of the same group of assets. Wrap funds, variable annuities, registered investment advisor client accounts and some mutual funds charge layered fees.
Breaking Down Layered Fees
Layered fees usually come in the form of an annual portfolio-management fee coupled with fees for individual investments within the portfolio. Firms typically assess annual management fees as a percentage of total assets in your portfolio. Underlying investments in the portfolio, such as individual funds, charge commissions, transaction fees and fees to cover operating expenses.
Investors try to avoid paying layered fees because, by definition, they are paying twice for the management of the same assets. Layered fees can easily add up to a significant loss in net value of the investment.
Any investment product that charges layered fees must disclose them in the prospectus. Layered fees are just one of many reasons investors should always read the prospectus of any investment they are considering. Investors may have to comb through statements, reading past the annual management fee to operating expenses and transaction fees to determine the total costs associated with the investment product.
While layered fees are generally undesirable, investors should consider paying them in situations where the primary manager adds value, typically when the complexity of the portfolio requires one. For example, if the portfolio includes investments in foreign companies, the inherent complexity may be beyond the ability of the investor to manage directly and, thus, warrant paying a layered fee.
How to Avoid Layered Fees
Investors intent on minimizing layered fees should consider a passive investment strategy rather than an active one. Passive investing involves building a portfolio to mirror a market index. It requires relatively little research and a minimum of buying and selling, which cuts down on fees of all types. Active investing involves employing research and analysis and frequent trading to beat average market returns, incurring all the associated fees. The passive investor prefers the guarantee of lower fees to the tantalizing possibility of beating the market.
The argument behind an investment strategy that prioritizes reducing layered fees is a simple one. Beating average market returns is at best merely a possibility, whereas fees are a certainty. The argument gains strength when you consider that actively managed funds do not, on average, outperform their passively managed counterparts. Doubtful of an individual fund manager’s ability to outperform the market consistently, converts to the passive approach have resigned themselves to earning average market returns and have turned their attention to reducing the cost of investing.