5 Ways to Keep Your Investment Adviser Honest

Not everyone is a do-it-yourself investor. According to Forrester Research, 30 percent of all investors want to delegate their investment decisions to someone else. Unfortunately, most “delegators” will spend more time shopping for a car than they will calculating the true cost of the investment advice they use to protect the nest egg they spend their life working to build. If you are a delegator here are some tips that will help minimize risk and give you a shot at having a successful relationship with your broker, financial adviser, or investment manager.

1. Show me the fees. Most advisers are biased toward investing your money in mutual funds that kick back yearly marketing commissions, which you pay for. Our friend Scott had a $6 million account with one of the largest Wall Street firms, and to make our point, we calculated his mutual fund fees, loads, and extra costs. Last year he paid about $138,000! We switched his portfolio to a MarketRiders portfolio and now he pays $18,000 per year. The solution? Ask for a comprehensive list of all the fees you are paying annually, including those for each fund and your adviser’s fees. Try to get these aggregate fees below 1.5 percent per year. To help get you started, we built a great mutual fund fee calculator to easily calculate these fees.

2. Get invoiced. Most financial advisers charge fees to your investment account. Ask them to instead send you an invoice, and write them a check. At a minimum, ask to be noticed when fees are deducted. That way you’ll stay aware of the cost for these services.

3. Show me the commissions. Ask your adviser to disclose the exact amount of commissions, credits, or any form of compensation he or she is paid as an incentive for having you invest in a certain financial product like a mutual fund, annuity, or life insurance product. Ask for the cost of an index fund alternative so you can understand exactly what it is costing you to be “sold” a particular product, and so you can justify its price in the future.

4. Deduct taxes paid. The average turnover for a mutual fund is 70 percent a year. That means nearly all stocks in a portfolio are sold each year and traded for other stocks. Turnover can create taxable income at year-end. Each February, after these taxes are calculated, give your financial adviser your federal and state tax rates and ask him or her to add up the taxes generated by turnover in your funds. Then withdraw from your accounts the amount you need to pay the taxes so you will be able to know the true after tax returns. After all, that’s what you keep.

5. Benchmarking. Many investors are happy when they make money in a fund. But that’s how amateurs think. Endowments and elite institutions judge their money managers against a benchmark. Each manager must, net of fees, outperform a comparable index fund that charges far lower fees. Have your financial advisor pick a benchmark for each fund and measure your adviser’s fund picking skills by how well that fund performed versus its benchmark. For example, another friend was bragging last week about how well his small-cap fund was doing this year-up over 20 percent! We pointed out to him that the ETF we recommend in MarketRiders portfolios, iShares S&P Small Cap 600 Index (symbol IJR) is up nearly 24 percent this year (as of December 15), and that’s just a computer-managed index of 600 small-cap stocks picked by market capitalization. Our friend learned that he paid 1.75 percent for under-performance and the fund has had 80 percent turnover this year, which will surely create taxable income. IJR charges only 0.2 percent in fees and has rarely sent a tax bill to holders.

We firmly believe that everyone, no matter what their level of investment experience, should take control of their investing by buying a well-diversified portfolio of index funds, periodically rebalancing their portfolio, and allowing their money to compound without excessive fees. So do Warren Buffett (read what he wrote about fees), John Bogle, David Swensen, and other investment industry luminaries. This is because fees charged by the financial industry, over time, decimate investment returns.

You worked hard for your money. These are reasonable ways to hold your adviser accountable. Don’t blame your adviser if in 15 years, a good chunk of your retirement nest egg has been siphoned away in fees. He was just doing his job.