In a recent article in Morningstar, John Rekenthaler talked about how Ameriprise and other brokerages/custodians/advisors offer funds based on how much revenue they get from the fund companies.  These so-called revenue-sharing agreements, he argues, are a way for the brokerages to hide the income they are actually earning from the advice they are providing to their clients, plus it biases their recommendations in favor of funds that pay them more rather than on quality, performance, or other factors that would provide better benefit to their clients.

This reminded me of the experience that a friend living in Baltimore recently shared with me.  Janice had started working with a financial advisor at a well-known financial company about five years ago after her husband had died. Needing help with her investments, she had interviewed a number of Registered Investment Advisor (RIA) firms as well as other big-name financial companies that offer financial advice.  Janice admitted that she had difficulty understanding the differences between them, so she ultimately focused on cost.  Most of the advisors were fee-only RIAs who all pretty consistently charged annual fees based on 1% of the value of an investment portfolio, which in her case amounted to about $10,000.  But the advisor she ultimately selected – a large company in the financial services industry – charged only about $3,500.  Or so she thought.

Last month Janice’s advisor contacted her to announce that the firm had terminated its relationship with its custodian (the company that holds and chooses the mutual funds in which she can invest).  They had switched to a different custodian with a different set of mutual fund choices, and her new annual fee would be 1.58% of the value of her portfolio, or over $14,000 per year moving forward.  Shocked, Janice demanded to know why the fees were going up so much.  She was more shocked by the reply: “Actually these new fees are lower than what you had been paying before.”

It turned out that although the advisor’s fee was relatively low, the fees embedded in the mutual funds available to Janice were extremely high.  Those fees had been buried in legal documents and had not been communicated to Janice in any clear fashion.  Renkenthaler told of a similar experience when writing his article.  The details of the Ameriprise agreements were uncovered, as he put it, “not from talking with Ameriprise but instead by combing through a legal filing.”

How can you determine just how much your financial advisor is costing you?  Don’t be afraid to ask!  But be sure to ask for disclosure of all his/her income related to your investments as well as the costs of the investments themselves.  Mutual fund annual expenses (including 12b-1 distribution fees) and sales loads, as Janice discovered, can really drive up the overall amount you are paying.  What’s typical these days? From what I’ve read and heard from other professionals, it’s probably about 1% for a $1 million portfolio plus an additional 0.75% – 1.00% for the investment choices, for a total of 1.75% – 2.00% annually. Larger portfolios generally cost less in percentage terms, while smaller ones may cost more.

While that may all sound high in dollar terms, good advisors do provide real value with investment risk management (especially during scary times when markets are plunging) as well as with advice in other areas such as tax and education planning that can save you tens of thousands of dollars.  Most importantly, they can help you improve your financial decision-making so that you maximize the likelihood of being able to do everything you want to do in your future.  How much is that worth?

The lesson for Janice was to probe deeply enough to uncover the real total cost.  The compensation model is a good indicator of behavior, and hidden fees should be taken as a warning.