Unless you buy and sell specific securities on your own, it’s likely that you are paying fees to one or more investment managers for handling your investments. If you buy shares in a mutual fund, the manager of that fund will receive fees in exchange for choosing investments for the fund. So, too, will a financial advisor who buys and sells securities for a specific client’s individual portfolio. In either case, investment management fees can take a chunk out of your returns. To ensure you aren’t overpaying for investment management, here’s a breakdown of how these fees work, what they include and how they are charged.
What is an Investment Management Fee?
When you hire someone to manage your investments, you’re likely paying a fee for it. Investment managers use their expertise and time to select securities and manage portfolios for their clients. Their clients then are charged a management fee for their services. These fees can also include investor relations costs as well as the administrative expenses of any given fund.
Essentially, management fees are the cost of having your investment or investments professionally managed. Management fees can vary from manager to manager and financial firm to financial firm, but are commonly a percentage of the total assets under management.Types of Investment Management Fees
Management fees, whether paid as a mutual fund expense ratio or a fee paid to a financial advisor, can range from 0.10% to over 2%. Generally, the range in fee amount is due to management strategy. For example, more aggressive investment portfolios tend to have higher management fees because there is more work involved due to the higher turnover of securities. Passive funds may have lower management fees because they select and then stick with the assets within the portfolio.
Here are some of the most common fee structures you’ll encounter when partnering with an investment manager.Flat Management Fees
A flat fee structure is probably one of the easiest fee schedules to understand. Typically, when you look at a mutual fund expense ratio to identify the management fees, it tends to be a flat fee. This means that the advisor charges a single rate no matter what asset or investment selection you make.
It’s important to note that some investment managers may choose to lower this fee as your portfolio increases. For example, if you have less than $1 million under management your fee might be 1.50%, while someone who has a portfolio between $5 million and $10 million may have a 1.25% fee.Tiered Management Fees
Under a tiered investment management fee structure, different asset levels are assessed various fees. By using this fee structure, all clients pay the same rate at the deposit level, no matter the account size. For example, the investment manager may charge 1.75% on the first $250,000, $1.50% on the next $750,000, 1.25% on the next $5 million and so on.Management Fees Assessed by Asset Class on Investment Balance
This fee structure charges clients a fee based on the assets within their account. This means that a client may pay little to no fees on cash reserves in their portfolio. Value investors often choose to use this fee structure since they generally sit on cash reserves and then use them to execute an investment strategy.
For example, the advisor may charge 1.50% on invested equity, 0.75% on fixed-income securities like bonds and 0.00% on cash or cash reserves. The client may benefit from this fee structure during times when they are building up cash reserves.Flat Fees and Annual Management Fees
In some situations, you may find yourself paying a combination of fees. This may require a little calculation on your behalf to determine the annual fee percentage. For example, you may have an annual base fee as well as fees for the investment within your portfolio. These fees can add up, so be sure to review the fee structure so you can understand the fees you’re paying.Wrap fees
Sometimes an investment manager will consolidate a client’s various fees into what is called a wrap fee. Such a fee may encompass the management of both retirement and non-retirement accounts; offering financial advice and planning services; brokerage services; and the fees accompanying any mutual funds or ETFs in which that manager invests.
Investment managers charge wrap fees as a 1% – 3% of the assets they manage for you. In a more traditional payment method, you might pay a smaller percentage, but separately pay trading fees or commissions. Wrap fee programs, on the other hand, “wrap” these fees, along with other administrative costs and investment expenses, into one charge.Do Higher Management Fees Yield Higher Returns?
You may think that if you’re paying a higher management fee, you should receive better returns. Unfortunately, this isn’t always the case. Active fund managers rely on inefficiencies and mispricing in the market. They then identify securities that have the potential to outperform the market. However, the efficient market hypothesis (EMH) states that prices fully reflect all available information. Therefore, according to the EMH, the current stock prices are a company’s intrinsic value. Because price movements are largely random and unpredictable, it wouldn’t make sense to misprice stocks.
The EMH implies that active investors cannot beat the market over long periods. In fact, according to the S&P Indices, 78.52% of funds underperformed the S&P 500. Essentially, active managers continue to show minimal performance when compared to their passive benchmarks such as the S&P 500 or Russell 2000. This means that even if you’re paying more in fees for an actively managed portfolio, you may not be reaping any additional rewards.Making Sure Your Financial Advisor Fees Are Fair
Before you agree to work with an investment manager or advisor, make sure you understand the fee structure and what services that fee includes. Some advisors may charge extra for certain services and programs. It shouldn’t be difficult for an advisor to explain how he or she is adding value to your accounts. If any advisors give a roundabout or elusive answer, you may want to do some further investigating or choose another advisor. It’s a red flag if an advisor tells you not to worry about costs.
You should know all their compensation sources, and if there are any other professionals they work with. You’ll also want to review other fees like expense ratios or transaction fees. It’s important to understand what you are paying for before moving forward. After all, you’re putting your financial future in their hands.The Bottom Line
Management fees are the cost associated with working with an investment manager or advisor. These costs can differ among financial professionals and how they manage your investments. By understanding how your investment manager earns their money and how they will work for you, you can select an investment manager that meets your needs.Tips for Minimizing Costs
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