All too often investors imagine that the cost of an investment can be fully calculated by knowing the fee charged by their Authorised Financial Adviser. Oh that it was that simple!
It’s important to know that the cost of investment is more than just understanding the level of up-front fees charged because, of course, there are more people involved in the investment of your money apart from the Authorised Financial Adviser that you see on a regular basis.
The prudent management of money involves the use of the latest information technology, the legal and fiduciary constraints of custodianship, the requirement to meet the on-going compliance cost of regulation, the book-keeping requirements to keep track of the number of units, tabulate distributions, re-invest distributions, pay tax on your behalf, compare and collate performance against benchmarks. There are also involved a number of internal committees with independent members who are there to oversee that all appropriate functions are carried out. All of these initiatives require intelligent people who have a long term career-path in the investment industry, and of all this comes as a legitimate cost to you.
However, sitting as a corollary around these very important procedures, is the potential to add layers of administration and double-up on administration costs so that your total costs escalates considerably. If investors are still only judging the cost of their investment by the fee that their Authorised Financial Adviser charges then they are looking in the wrong place to know the total cost.
It is vitally important to know the total cost because the total cost affects the return that you ultimately receive. What is common-place in the industry is to make the front-end, the part you see easily as ‘cheap’ as possible and then make the back-end (those costs which are deducted before you get your return) loaded up with all the other costs so that you are unaware of just what this total percentage is.
This is detrimental to you from a tax perspective also. Those costs which are declared at the front-end are costs which you can claim back against your tax, whereas fees at the back-end are not disclosed to you so can not be claimed back against your tax.
Therefore, all too frequently, the industry has Authorised Financial Adviser charging next to nothing for a plan, disclosing that they charge a low fee in terms of managing your portfolio, but unbeknownst to you, receiving part of the back-end fees charged by the fund managers paid out to them as a loyalty bonus. This increases their income but not in a way that you can see or measure. This is called a ‘trail commission’.
It is in your best interests to know and understand the total cost of being an investor and to have as much of that total cost paid directly by you up-front so that you can claim this against your tax. Ultimately, you will pay these costs anyway so it might as well be in the most tax efficient way for you.
In our education sessions with new clients we step through the different ways of investing money and how some can be more expensive than others. For instance, relying on stock pickers and market timers to provide portfolios for you means that you have to pay for all the extra staff plus all the transaction costs of trading your shares on a regular basis. All of this increases your hurdle rate of being able to make a profit. It is therefore very difficult for a lay-investor to have any idea of the total cost that they are paying. So it is vitally important, before you invest, that your Authorised Financial Adviser is able to take you through the true level of costs. All too frequently the average industry adviser doesn’t even know the sum total of your future costs.