What Are Layered Fees?
An investor pays layered fees when they pay multiple sets of management fees for the same set of assets. These fees are categorized separately, but inherently are just fees for the management of the same assets. Investors can incur layered fees when investing in products such as wrap funds, investment advisor client accounts, and fund of funds (FOF) investments.
- Investors pay layered fees when they pay multiple management fees for the same group of assets.
- Layered fees are associated with actively managed investment products such as wrap funds, fund of funds, and investment advisor client accounts.
- Most investors avoid layered fees unless they seem clearly justified, such as when the underlying investments are inherently complex.
- Any product that charges layered fees must disclose those fees in the product’s prospectus.
- Fees can be presented in many different forms, including asset management fees, commissions, transaction fees, and other fees designed to cover operating expenses.
- Passive investment strategies have become increasingly popular as a low-cost alternative to actively managed funds, which have layered fees.
How Layered Fees Work
Layered fees are associated with actively managed investment funds in which the assets held in the portfolio have their own individual management fees.
For example, an investment manager might offer a portfolio of exchange-traded funds (ETFs) or mutual funds. In that scenario, the investor pays fees not only for the investment manager but also the fees that each individual ETF or mutual fund comes with. This adds fee upon fee.
Investors try to avoid paying layered fees because they effectively entail paying twice for the management of the same assets. Layered fees can easily add up, dragging down investment returns.
To protect investors, any product that charges layered fees must disclose those fees in the product’s prospectus. This is one of the reasons why it is essential for investors to carefully review the prospectus of any investment they are considering.
The True Cost of Investing
Depending on the structure of the investment product in question, investors may have to comb through the prospectus documents carefully to determine its true costs. This is because fees can be presented in many different forms, including asset management fees, commissions, transaction fees, and other fees designed to cover operating expenses.
Although investors generally avoid layered fees, they may sometimes be justified. Investors should consider paying layered fees in situations where the investment manager clearly adds value, such as when the assets within the portfolio are very complex. For example, if the portfolio includes investments in foreign companies, the added complexity of evaluating those securities may justify paying a layered fee.
Investors intent on minimizing layered fees should consider a passive investment strategy rather than an active one. Passive investing involves attempting to match the market rather than outperforming it. Many products exist to help achieve this goal, such as index funds and ETFs.
In addition to requiring little to no oversight, passive investment strategies have substantially fewer fees than active ones. Over time, this benefit of lower costs can significantly improve investment returns. In fact, passive investment strategies actually outperform active investment strategies, on average, after taking the cost of fees into account. For these reasons, passive investing has become increasingly popular in recent years.
Example of Layered Fees
Emma wishes to gain exposure to foreign stocks in her portfolio. She does not have the time to diligently research foreign stocks herself or to go through the effort of having to buy multiple, individual stocks, so she chooses to invest in an active investment fund that is focused on foreign stock investments.
The fund she chooses, XYZ International Equities, has a layered fee structure. Specifically, the fund has a 2% management fee and holds a basket of international ETFs. On average, those ETFs have their own fees which work out to roughly an additional 0.75% annually. Therefore, Emma knows that if she invests in XYZ, she will need to earn at least 2.75% per year to make up the cost of its fees.
Alternatively, Emma could identify the exchange-traded funds (ETFs) herself and invest in them on her own, avoiding the 2% management fee altogether. In addition, by investing in an ETF, she also avoids having to research individual foreign stocks herself and leaves that up to the ETFs.