The Costs of Investing

by James Lindsay

Last month, James Lindsay from Bamboo Money detailed how to keep your money safe. Now that you’ve learned how to make sure you have access to your funds when you need it, here’s some advice on cutting down on investment costs.

There’s basically two ways of paying for face-to-face financial advice and they come with wildly different costs. The first way is called ‘fee-only’: this means that you pay an advisor your own money for their service at the point at which they provide the service, meaning you actually hand over money directly, whether it’s in the form of cash or a bank transfer, but you actually have a transaction between you (the client) and the advisor (the service provider). If you’re paying an advisor with CFP credentials, then expect to pay anywhere upward of US$100 per hour. Whether you pay hourly, for a specific job, or according to their success with your investments depends on the advisor. But as long as the advisor only takes money from you – and they don’t take any commissions from anyone else – then they retain an unadulterated focus on serving your interests. This is a Good Thing.

The dark side is called ‘commission-based’. It means the ‘advisor’ is actually a salesman because he makes his money if – and only if – you buy a product from him. You hand over no money directly to the ‘advisor’, but you do pay him. First, on his recommendation, you transfer your money into a financial product; second, the product provider pays commission to the ‘advisor’; finally, the product provider takes fees and charges out of your investments, some of which compensates the product provider for paying the commission, and some of which is pure profit. As a retail investor, what you must, must, must always remember is that these fees and charges are not ‘a much of a muchness’, and they are not similar for commission-paying and non-commission-paying products.

This shouldn’t be surprising; it’s only basic economics. There are products that have fancy sales networks, and those products have higher charges. And there are products that don’t have fancy sales networks, and these products have lower charges. If a salesman is prepared to visit your office then his products cost more than equivalents where you look for them yourself.

Getting specific with some figures, the financial journalist Naomi Rovnick recently compared the cost of investing US$1,000 per month over 25 years into a long-term product from a British insurance company (a product marketed to expats) with the costs of a cheap global index-tracking exchange traded fund (ETF). The results are mind-blowing. Assuming the same rate of return of 7.6 per cent per year, the insurance product cost over US$250,000 more and is also less flexible. There are supposed advantages, such as a range of mutual funds, but this is only an advantage if it produces better returns, and there’s no guarantee or even likelihood of that. What about service? The advisor/salesman will tell you he’ll work for you for the duration of the investment, but on that basis then the advice is very much not free, which is how it’s almost always marketed. And that’s saying nothing about the relative cost of the service: US$10,000 per year, compared with, say, US$5,000 or less if you use a fee-only provider.

The costs of advice and the costs of investing are the big costs, long-term. There are other, smaller costs, like the cost of your banking, but they pale into insignificance if you pay too much for your advice and your long-term investing. Two rules: pay your advisor directly for advice, so you know your advisor is working for you and you alone, and compare the long-term costs of investment products. Salesmen will try to tempt you by talking about returns, but it’s the cost of a product that makes a much bigger difference to your outcomes. The other big draw on results is tax – and I’ll deal with that next month.

James is the editor of ‘eg’, the online money magazine for expats in Shanghai. Visit www.egmoneymagazine.com to read more about making the most out of your money.