Tiny fund fees take a big savings bite

President Barack Obama delivers remarks at AARP headquarters in Washington, D.C., on Feb. 23, 2015, regarding retirement security. Obama was promoting a new federal rule to ensure that financial advisors actually work for consumers.
Jim Watson | AFP | Getty Images
President Barack Obama delivers remarks at AARP headquarters in Washington, D.C., on Feb. 23, 2015, regarding retirement security. Obama was promoting a new federal rule to ensure that financial advisors actually work for consumers.

The pennies on the dollar that Americans pay for financial advice is costing them billions of dollars in lost savings.

That's the conclusion of a White House report supporting the administration's proposed new rules governing financial advisers. President Barack Obama wants to crack down on brokers who recommend investments based on the fees they earn instead of the benefits to their customers.

"It's a very simple principle: You want to give financial advice, you've got to put your client's interests first," Obama said, announcing the new rules at a meeting of retirees this week. "You can't have a conflict of interest…. And if your business model rests on taking advantage, bilking hardworking Americans out of their retirement money, then you shouldn't be in business."

For decades, investment fees have largely been an imponderable quagmire for small investors trying to stash away a nest egg for retirement. For about half of those savers, mutual funds, which sell shares in a pool of money that's invested in stocks or bonds, are the preferred investment vehicle. But despite some improvements in disclosure, the true cost of mutual fund investing remains largely opaque to most households.

Many turn to brokers, who earn commissions selling investments, to make sense of their choices from among nearly 8,000 different funds. But the White House says too many of those savers aren't getting reliable advice.

"Advisers accepting conflicted payments face a conflict of interest because the advice that is best for their own bottom line may not be the advice that is best for their customers' savings," according to the report.

Proposed new rules may help. But small investors who do their homework can avoid big costs from those little fees. Here's what you need to watch out for:

What are these fees the president is talking about?

Some are charges to cover the expenses of running a mutual fund: fund manager salaries, the cost of buying and selling investments, marketing expenses, accounting and legal fees and a variety of other costs of doing business. Some of these are spelled out in the prospectus, the detailed disclosure document that few investors ever bother to read.

Others aren't. Fund fees come in lots of other guises; there are purchase fees, redemption fees, exchange fees, account fees, among others. The fees are typically assessed as a percentage of the amount you invest.

How does the broker get a cut?

To attract more investors, mutual funds also pay a commission to brokers to sell shares to their customers. That's one of the fees the administration is targeting.

There are a number of types of commissions, also known as "loads." But they generally fall into two categories: an upfront fee when you invest or a "deferred" load that's charged when you sell your shares. (In some cases, if you hold onto the shares long enough, the deferred charge goes away.)

Many mutual funds will hit different customers in the same fund with different fees by creating multiple "classes" of shares. Class A shares, for example, might come with a front-end load, while Class B shares include a deferred charge. No Load shares may not charge a sales commission, but they still charge fees, often rolled up into a single number called an "expense ratio."

You can also expect to pay higher fees than big investors who buy into the same fund you do. Most funds offer so-called "institutional" shares with the lowest fee (per dollar invested) for investors who buy big blocks of shares.

So what do I get for all these fees?

Not much, according to many researchers. In theory, the sales commission is supposed to pay for advice that helps you pick funds that generate a higher return. But there's little evidence that funds that charge more in commissions generate higher returns.

In fact, White House economists say investment fees reduce annual returns on retirement savings by a full percentage point.

One percent doesn't sound like much. How much is all this costing me?

That's one reason many savers don't look hard enough at fees: They're usually just a few pennies on the dollar. But the compounded impact on your savings, especially over a lifetime of saving for retirement, can cost you thousands of dollars.

For example, take a $10,000 investment in a mutual fund that invests in stocks and generates an 8 percent annual return. If you paid a 2 percent upfront load and a 1 percent expense charge, you'd get back $19,134 after 10 years. But you would have paid $2,455 in fees and lost earnings, according to a Securities and Exchange Commission calculator.

Obama: New rules for brokers & retirement accounts
Obama's new rules for brokers & retirement accounts   

The White House estimates the overall cost to Americans at about $17 billion a year. The administration figures that number will likely rise as millions of retirees take savings from their company sponsored 401K plans and roll it over to individual retirement accounts.

What would the new rules do?

Among other things, brokers selling mutual funds and other investments would be held to a higher legal standard, known as a "fiduciary," that requires them to put your financial interests ahead of theirs. Many financial advisors already have to meet that standard, but not all brokers who sell retirement investments have to follow those rules.

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