What Investors Know About Fees: Next To Nothing

High fees are the reason your retirement fund falls short

What do you know about the fees associated with your retirement investments? Forbes cites Scott Puritz’s testimony to the U.S. Senate confirming that consumers are often in the dark about how much they actually pay in hidden fees.

You’ve probably seen the Charles Schwab commercial with a Millennial son asking his boomer dad how much his broker charges and the father says, “I dunno.” Turns out, U.S. investors are just as clueless as that dad about the fees they pay.

That’s the maddening finding from a new survey of more than 5,000 households by the financial research firm Hearts & Wallets. “It was dismaying to me how few people are aware of what they are paying,” said Laura Varas, founder and CEO of Hearts & Wallets.

The dispiriting specifics:

  • 37% said they didn’t know what they pay to use the services of their financial firm
  • 30% think they pay “nothing” to the financial firm
  • 72% of those who said they paid “nothing” to the financial firm also thought they paid “nothing” for the financial products they own

Varas told me she was “flabbergasted” by that 72% finding.

And the investors who pay a fee based on a percentage of their account value underestimated it — their most common answer (from 36% of them) was “less than 0.50%,” but Hearts & Wallets says most of them probably pay 0.50 to 2.0%.

Can you think of any other products or services where you have no idea what they cost? I doubt it. And, Varas said, the percentage of investors who told Hearts & Wallets they understand how their financial firm earns money “hasn’t changed in six years.”

An Eye-Opener on Investment Fees

In case you think these investment fees paid to financial advisers and for financial products (such as mutual funds, stocks, bonds and ETFs) don’t amount to much, here’s an eye-opener:

A 1% annual fee for an initial $100,000 investment amounts to nearly $28,000 over 20 years, assuming the portfolio grows by a modest 4% annually, according to the Securities and Exchange Commission’s (SEC) Investor Bulletin, How Fees and Expenses Affect Your Investment Portfolio.If that $28,000 could have been invested, the SEC says, the owner of that portfolio would’ve earned an extra $12,000.

Demos, a nonprofit that blew the lid off 401(k) fees in 2012, estimates that retirement savers alone paid $73 billion in fees in 2013, or 0.60% of their total assets, on average. Incidentally, despite the fanfare over new federally-mandated 401(k) fee disclosures that followed, a LIMRA Retirement Research study showed that 22% of employees still think their 401(k)s are free. (Of course, 401(k) plan disclosure statements that are 10 pages long and written by lawyers don’t help matters, not to mention that many of those fees are still mighty hard to ferret out.)

How can so many of us still be so clueless about investment fees? There are a number of reasons, but the chief one is that the fees are often hidden, baked in and extracted in multiple guises.

The Frankenstein Approach to Fees

“It’s almost a Frankenstein-like Value Added Tax,” said Varas. “Each person takes a toll as they touch the connection between the investment and the consumer.”

Scott Puritz, Managing Director for the investment advisory firm Rebalance, told a U.S. Senate Committee hearing last summer that some of his clients thought they were paying a 1% annual fee for investment advice but didn’t realize they were actually paying more than double that, according to Detroit Free Press columnist Susan Tompor.

Here’s how this could happen: Say you hire a financial adviser and purchase mutual funds from him. The adviser probably charges a percentage of your assets, typically from 0.60% to 1.50%. The fund gets some or all of its cut through an annual fee known as an “expense ratio” — the percentage of your money that the fund charges to cover operating expenses. If the expense ratio is, say, 1.00%, that means you’d pay $1,000 a year for a $100,000 investment. (According to a recent survey, Morningstar’s John Rekenthaler noted, just over half of investors estimated that fee would equal less than $500.)

And then there are mutual funds that also charge upfront fees, or loads, of up to 8.5%. Plus, there are the brokerage commissions every time you buy or sell stocks, bonds and funds.

Why Things May Change for the Better

But, as the son on the Schwab commercial says to his father: “Well, the world’s changing.”

For one thing, the Obama administration’s new “fiduciary rule” or “conflict of interest” rule might make the fees you pay for retirement investments clearer and, supporters hope, lower. The rule, which will take effect fully in January 2018, will require advisers to: put their clients’ interests first for their retirement money, disclose any conflicts of interest and spell out how they get paid. The fiduciary rule may partly explain why Charles Schwab just trumpeted that it’ll soon stop selling load funds, with their higher costs. Demos estimates that the fiduciary rule could save retirement investors nearly $25 billion due to lower fees and, if the savers wind up moving money into lower-cost funds as expected, they might earn an extra $60 billion in their IRAs and 401(k)s.

Another healthy change on the investment fee front: so-called “robo-advisers” — online firms that invest your money automatically, like Betterment, Wealthfront and Personal Capital. These types of companies specifically promote themselves as being fully transparent about their low fees, compared with full-service brokerage firms and financial planners. “I love the way they’re bringing pricing to the forefront,” said Varas.

But roboadvisers are mostly targeting young investors, who they think are more likely to prefer investing electronically, rather than with human advisers.

The SEC itself might step in to make mutual fund fees easier for consumers to understand. Its Investor Advisory Committee last week proposed that funds be required to tell investors how much they charge in actual dollars, not expense ratio percentages. Unfortunately, as Rekenthaler wrote in an article about this proposal, the committee has so far only had one of 13 recommendations enacted by the SEC. And a similar proposal was shot down by the agency 12 years ago.

“I would love to see something like the SEC proposal,” said Varas. “But I think something like it is going to happen no matter what. There’s so much consumer demand about how firms earn their money.” Evidence: When Hearts & Wallets asked investors what they want from their financial firms, the No. 1 answer (from 56% of those surveyed) was that “Fees are clear and understandable.” Right behind that was that the firm “Has low fees.”

None of these changes will make investors fully knowledgeable about the fees they pay. But at least they’re baby steps in the right direction. “A couple of ice cubes can lower the temperature in a cup of tea,” said Varas.