This scenario is analogous to a home improvement contractor quoting your renovation only in terms of what he makes in profit on your job. Excluding the costs of the subcontractors can make for a nasty surprise when the $35,000 bill arrives after the $10,000 quote.
It's actually more insidious than that. Imagine your surprise when the contractor arrived and asked for the $10,000, then had your bank deduct $25,000 from your checking account without your knowledge. Then arrange for the bank to withdraw the money without an entry on your statement. This is exactly how the mutual fund business operates because they withdraw their fees from your balances before they put the value on your statement. The level of opaqueness is astounding. Yet many, but not all these costs are discussed in the prospectus, which no one ever reads.
Getting to the bottom of costs is much like the proverbial iceberg. The vast majority of an iceberg's mass is hidden from view under the surface. And so it is with advisory fees. I surely understand how confusing this all is and how clients merely want to be told what to do by someone they trust. So, what can you do to protect yourself without having to become an authority on the rules and how fees work?
- Inquire about your costs. This gets particularly tricky when mutual funds are in the mix. It is highly likely today that a discussion about cost would only involve advisory fees laid on top of mutual fund fees; "the broker's 1%", if you will. I recommend that you ask about product costs, and dig deeper than the expense ratio.
- Listen with an ear toward broker word-smithing. This can happen when a client asks about fees and the broker says this: "my all-in fees are 1%". It would take an inquisitive and informed client to ask further "is your 1% the totality of all costs my account incurs?" I have seen many brokers say yes to this question even when that was terribly false. Proving it wrong takes an even more inquiring mind.
Let me be clear. I'm not claiming this to be theft. I'm merely stating that lack of disclosure coupled with lack of curiosity can be an awful combination for investors. Mutual funds are a legitimate business and most offer valuable services to investors. But investors need to be much better informed and choose advisors carefully who operate in a full disclosure environment and who are remarkably well informed to boot. Clients also need advisors with the moral clarity to tell it like it is.