Are sales commissions eroding your nest egg?
Earlier this year I asked this same question about mutual fund fees, those widely-imposed but little understood costs that you’re charged when you invest – and often on an annual basis. But investors – especially those investing for the long haul – need to understand that fund fees are not the only cost that can erode strong investment gains. Sales commissions can also add up, and because brokers are not required to disclose them, they can also sneak up on you.
Now imagine that you go to a broker or a wealth management adviser who sells you on a package of tools and investments to set you up for retirement. These might include stocks, mutual funds as well as life insurance and/or an annuity. You could end up paying a sales commission on all three … in addition to the fees that will cover fund maintenance.
In my earlier piece, I explained how even fees of 1% or less can take a big cut out of your investment gains, when you see them in terms of the gains you might reasonably expect. A fee of 1%, for example, takes an 8% return down to 7%, which is effectively a fee of 12.5%. That’s right.
But sales commissions for life insurance and annuities are often significantly higher that one percentage point. And when you’re paying multiple commissions for multiple products you’re talking sometimes astronomical amounts in the name of a more secure future.
What Investors Should Know
While it’s not always possible to avoid sales commissions altogether, a good start is to educate yourself and understand what choices are available to you. Here’s some advice:
- Ask about sales commissions. Because investment advisers are not required to disclose this information, they may not. By asking the question you should be able to get more information but also pay attention to the way investment advisors classify themselves. Fee-only advisers typically are paid fees but not sales commission. And while this sounds a lot like fee-based advisers, there’s an important distinction. Fee-based advisers often charge a fee and a commission … but you might not know about the commission unless you ask.
- Understand that more is not always more. We’re all taught that diversifying is one of the fundamental rules of investing. But diversifying does not need to mean purchasing more investment tools. Ask yourself how many mutual funds you really need to have a diversified investment strategy, in view of other investments you might hold in a 401(k) or other accounts. Likewise, if you already hold stocks and life insurance, consider whether an annuity is bringing you added protection, or just added costs.
- Understand conflicts of interest. Does your investment adviser earn more to sell you an investment fund managed by his or her employer? Many do. Before you buy, find out the real motivations for promoting these investments.
- Look for “fiduciary standard.” Quite simply, this means that the broker or adviser or insurance salesperson who is working with you is committed to acting with the client’s best interest in mind, provides full disclosure of the relevant facts and avoids conflicts of interest. The common alternative to fiduciary standard is what’s called the “suitability standard,” and while it might sound as if it imposes some safeguards, all it really requires is that the broker recommend investments or other tools that are “suitable.” Consider that there are a probably an infinite number of funds or annuities that are conceivably “suitable” for most investors, and you see the problem. This suitability standard still leaves your adviser plenty of wiggle room to recommend investments designed to benefit him more than you.
- Contemplate a DIY approach. As I noted in my earlier piece on fund fees, sometimes the fees you pay are money well spent. And this can also be true for commissions. If you are time-strapped, number-challenged, or just the kind of person who needs professional input, it may make sense to handle at least some of your investments through professionals. On the other hand, if you have time to put in the research you may be able to safely avoid at least some sales commission.
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