The Costs of Investing

Much has been said recently about a new sense of frugality in our economy. Down markets and higher levels of unemployment have a nasty way of forcing people to be more frugal. Whether this frugality continues is yet to be determined, but one thing is certain--consumers are more price conscious in today's environment.

So what is the price of investing? When I say price, I'm referring to the transactional or management cost of investments. The risk associated with stocks and bonds and the potential cost due to realized losses is another topic and a separate discussion. There can also be tax costs associated with investments which I won't address in this post.

The do-it-yourself investor will need to set up an online trading account and will typically pay a trading commission of $8-20 each time they buy or sell a stock. There might also be an annual maintenance fee. Mutual fund trades can have transaction fees, or might be "no-load," which means there isn't an initial cost to purchase the shares of the fund. Mutual funds also have ongoing management and trading costs, which can be quite significant. These costs are disclosed, but not easily obtainable or comparable for the individual investor. Mutual funds can also have front end (purchase) or back end (sales) charges.

The investor working with a professional financial advisor will typically pay on a transaction or ongoing management basis. Some advisors will also consult on an hourly basis. The transaction cost is often a commission or front end charge that is passed on to the advisor. Mutual fund management fees are also shared with advisors at times and surrender charges cost the investor for selling out of an investment before a specified period of time has passed. An ongoing management fee is typically charged based on the value of an investment portfolio.

The myriad of costs, fees, loads and commissions are often complex, confusing, and at times, unnecessary. They tend to enrich the advisor at the cost of the client or investor. Although any professional investment advisor needs to be compensated to make a living, I recommend three things to keep in mind with regard to investment costs.

1) Costs should be fully and completely disclosed. Financial advisors are more likely to hide their fees if they are unnecessary or unreasonable.

2) Costs should not be charged at multiple layers, if possible. Investing can be done in an efficient, institutional manner where costs aren't charged at many layers without any corresponding benefit.

3) The financial advisor's compensation should be fully aligned with the client's best interest. An advisor shouldn't be paid solely for a "sale" without any ongoing accountability for client success and service. Commission-based salespeople are motivated to convince you that their solution is the best because that is how they are paid.

Investing significant financial assets in an appropriate manner can be critical to a prosperous and flexible financial future, but careful attention should be given to the price of investing before moving forward with an approach.