I'm sure the financial advisor meant well
but is there a fee for their "free" advice?
TL;DR: Follow the money. Understand all your investing fees. If someone claims to offer "free" financial advice, they're likely making money another way—often at your expense.
The Con: "Free" Advice
You know what they say, freedom isn't free, and neither is a financial advisor's time. I have worked with several people whose "free" financial advisor took advantage of them. I know this grift because I fell for it years ago. The conversation typically goes like this:
"How much does your advisor charge?"
"Nothing! They're paid by the bank."
"Then how do they actually make money?"
"I'm not sure, but I don't pay any monthly fees."At this point, I ask them to review their most recent account statement or provide me with the account's ticker symbols. We found that the advisor put them in a fund with a "frontload" fee. A frontload fee is a mechanism that pays the advisor a commission for each sale. So, if you invest $1,000 in a fund with a 5% frontload fee, your account will receive $950, and the company will keep $50 to pay the advisor. Then, every month you contribute, they deduct that 5% from your contribution. These advisors won't tell you most of the time, and if they do, they sell it as the cost to get these smart people to actively manage the investment.
The Cost
Let's do the math: A $10,000 investment held for 25 years, averaging 10% annual returns, would grow to approximately $108,000 without front-end fees. With a 5% frontload fee, your starting investment drops to $9,500, resulting in a total of $102,000 after 25 years. That "free" advice cost you $6,000 on a single transaction.
Making an Informed Choice
Before buying a fund or ETF, research it to determine its costs.
Advisor Fees - What does it cost to talk to your advisor?
Assets Under Management (AUM) fee - You are charged a percentage of your account value. The cost will be on either your monthly or annual statement and look similar to:
In this example, the AUM fee is 1%. Take the total account value at the beginning of the month and multiply it by 1%/12. In our example, you are being charged $8,808 a year ($734 x 12 months) for your account. Now ask yourself, am I getting $8k of value from my advisor?
Flat Fee - The advisor charges a set amount regardless of the account size. The charge may be a monthly fee, one-time, or on a service-by-service basis. If you have a flat-fee advisor, divide your total account value by the amount you are paying them to compare it to the AUM cost of the AUM advisor.
Fund Fees - What does it cost to buy the product from the fund company?
Front-end Fee - fees paid when you make the initial investment.
Expense Ratio - fees paid on an ongoing basis.
Deferred Fees - fees paid when you sell the fund; these can also be called back-end fees, deferred fees, early withdrawal fees, or surrender fees.
When researching a fund or ETF, look for these values. Morningstar is an excellent site for researching the fees in Mutual Funds and ETFs.
Examples of Front-end and Expense Ratio fees
These fees are charged regardless of the fund's performance.
Let's see what each fund would cost:
ABALX will cost more upfront and every year after. Despite ABALX's slightly higher performance rate, it doesn't overcome the initial 5.75% disadvantage. In addition, the .56% expense ratio of ABALX results in a larger yearly cost than the .06% expense ratio of VBAIX.
Early Withdrawal Fees—Annuity and insurance products are notorious for charging surrender fees. You could be locked in for years before you can surrender without getting fleeced. Funds with early withdrawal or “deferred” fees tend to have a 6-month or 1-year lock-in period. If it is called a "back-end" fee, that means you will always be charged, regardless of when you sell the fund.
Another Option
There is a wealth of research on successful investing using low-cost index funds. I won't spend the time repeating it here, but long story short - there are significantly fewer active funds that outperform index funds over the long run. Check out the SPIVA report, which compares actively managed funds against index funds.
You can read all about it in John Bogle's book, The Little Book of Common Sense Investing. You can listen to Paul Merriman talk about the #1 reason to own index funds here.
Before acting on any investment advice, research similar low-cost alternatives. A simple Google search can reveal comparable index funds with significantly lower fees. Ultimately, you are the only one responsible for your financial decisions; take that responsibility seriously at all stages of your financial journey.
Links
Morningstar - https://www.morningstar.com/
VBAIX chart - https://www.morningstar.com/funds/xnas/vbaix/price
ABALX chart - https://www.morningstar.com/funds/xnas/abalx/price
FCISX chart - https://www.morningstar.com/funds/xnas/fcisx/price
2024 SPIVA Report - https://www.spglobal.com/spdji/en/spiva/article/spiva-us
Merriman: Reason to buy Index funds - https://www.paulmerriman.com/could-this-be-the-1-reason-to-use-index-funds