What are you really paying for advice?

Posted By Paul

I don't want to come out as the guy who says "you're being robbed if you have an adviser" because it's really not true. I know people who have been with their advisers longer than they have been with their spouse, and trust them totally, and that's great.

HOWEVER, I wanted to lay out a little scenario so that people know HOW you're paying for advice and how much it might cost you.

Let's say that you have $10000 and you want to put it into a mutual fund. We'll go through it step by step, and cover the cases where you have an adviser and one where you don't.

Step 1: Opening the account
With an adviser: You tell your adviser you want to invest $10000 in a mutual fund, and they open an account for you, most no cost advisers work for a specific brokerage company, so you'll get an account with that company (for this example, I'm going to use Black Rock as the family of funds).

Without an adviser: You create an account somewhere by yourself, the advantage is that you can pick from ANY broker you want. So let's say you decide you like Vanguard funds so you open an account with them.

Time advantage:
With the adviser you probably save the time of picking a brokerage. You probably fill out more or less the same forms either way.

Money advantage:
None. Either way it's easy to find a place that will let you open an account for no cost.

Step 2: Picking the fund

With an adviser: Your adviser will probably ask you a few questions and say something like you want to invest in a "Mid Cap Value" fund (this is just an example) and present you with a fund from their brokerage company. In this case for this adviser it would be BlackRock Mid Cap Value fund (BMCAX).

Without an adviser: You would have to decide what type of fund you want, this could take some time but would probably come down to how much you are willing to risk loss of your investment versus potential returns.

There are tools that help you with this, such as this asset calculator.

For the sake of this illustration I'm going to assume that you ALSO decide that you want a "Mid Cap Value" fund. I did a quick check in Vanguard for their Mid Cap Value Fund (VMVIX).

Time advantage:
You saved the time of picking and researching the fund, which could be a lot depending on how much time you like to research that sort of thing.

Money advantage:
At this point, none.


Step 3: Investing the money.

With an adviser: You give your check to your adviser for $10000 and they deposit it in your account and buy the shares. HOWEVER, advisers generally sell loaded funds that have loads or fees involved. In this example BMCAX has a 5.25% front-load. So of your $10000, $525 comes off the top and the remaining $9475 gets invested in the fund (there might even be an additional transaction fee depending on your adviser).

Without an adviser: You give your check to Vanguard and they deposit it. VMVIX has no loads so your whole $10000 goes into the fund (I'm pretty sure Vanguard doesn't charge a transaction fee).

Time advantage:
None really. Putting the trade through is easy either way.

Money advantage:
The adviser route has cost you $525.


Step 4: Fees associated with the fund.

With an adviser: There will be fees associated with the fund.

Without an adviser: Again, fees associated with the fund.

Time advantage:
None.

Money advantage:
While your money sits there, some percentage of your investment goes to administrative fees. For our Vanguard fund it's .26%, for Black Rock it's 1.25%. As far as the fees associated with the fund the Black Rock costs almost five times as much.


Step 5: Fund performance.

With an adviser: You sit back and hope your fund goes up.

Without an adviser: Same thing, fingers crossed.

Time advantage:
None, you sit back and wait.

Money advantage:
Well that depends on how well your fund does. Here are the two funds for the last six months. Notice how similar they are? Maybe in some cases the fund your adviser suggests will dramatically outperform a similar fund, but I'd say most of the time it won't


Step 6: You sell it.

With an adviser: You ask your adviser to sell your fund.

Without an adviser: You contact the broker directly and put the trade through.

Time advantage:
Essentially none, contact your adviser vs. contacting the broker directly.

Money advantage:
In this case none, but be aware that many adviser based funds also have a deferred or "back end" load, which means that a percentage of your investment is taken out as a fee when you sell.

Total difference:

In my example for our $10000 investment, by using an adviser we paid $525 up front, about 5 times the annual fee percentage, and the same fee (zero) at the end. Fund performance was essentially the same.

For that money what we got was the suggestion of the fund category.

If the fund recommendation is worth the money to you, then by all means pay it. In general I would recommend that everyone go through this exercise with their funds and find out:

1) Are paying a lot of front and back end loads for their funds?
2) Are the fee expenses for their funds unusually high?
3) Are the funds performing better than similar funds that don't have the fees?

If you read my previous post:
A Few Quick Tips On Mutual Funds

You'll see how easy it is to use web resources to check your funds.

If you know the answers to these three questions then you can really decide if the money you are paying to your adviser is worth it.

Article: 6 Money Dilemmas

Posted By Paul

Found a cool article on CNN Money today that listed some of the classic "which should I do" scenarios and gave suggestions and information.

The six scenarios the article talks about are:

1) Pay off a credit card OR fund your 401(k)

2) Save in a Roth 401(k) OR a regular 401(k)

3) Lease a car OR buy a car

4) Prepay your mortgage OR invest

5) Buy a home OR rent a home

6) Take Social Security early OR late

Here is the link to the article:

Six Money Dilemmas

Why Do Bond Funds Go Down?

Posted By Paul

Okay, this is one of my favorite things about Frugalize, the opportunity to have a question that I don't know the answer to, take some time to find out the answer, and then share the answer in the hope that someone else may be wondering the same thing.

So the question I had was:

"If a bond fund is a mutual fund that invests in bonds, and since bonds are essentially loans to corporations or the government that have an interest rate, then how can a bond fund go down in value?"

Is it loss from defaulting on the bonds? Money so that the fund manager can buy nice things for his or her family?

My thought was that such a fund would be conservative (that's true) and since they're just sitting there accumulating interest, that they should only go up in value (that's not true).

The part I was wrong about was that in addition to holding bonds until maturity, bond fund managers can and do trade them on a secondary market. Bonds are constantly being bought and sold on a market not unlike the stock market. The basic mechanism for bond value is the idea that if interest rates go down then older bonds become more valuable (a super simple example: if the current interest rate for bonds is 5% but you have a bond with an interest rate of 10% then people will be interested in that bond and will want to buy it). The opposite is true as well, if interest rates go up then people would rather buy a new bond than an old one with a lower interest rate so that bond becomes less valuable.

It's also true that sometimes entities default on their bonds, but this is generally rare, and it's also true that bond funds have expenses that include paying the fund manager to manage it (for more info on mutual fund expenses see the posting on 'A Few Quick Tips on Mutual Funds'), but usually these don't significantly factor into the value of the fund. Generally the fluctuations in a bond fund relate to the value of the fund change as the bonds within it fluctuate in value.

Confusing? You bet. I guess one thing to keep in mind is that even the conservative bond funds aren't a sure bet. So if you ever need to invest your money in something that has absolutely no risk, then you'll have to start looking at things like CD's, savings bonds, and savings accounts.

A Few Quick Tips On Mutual Funds

Posted By Paul

I found a great web page resource for mutual funds that I thought people would find useful. It's:

http://www.morningstar.com/

It lets you look up some great info on a mutual fund for free.

Here are a few key bits of info they provide that I find useful when evaluating a fund:

Front Load %
Deferred Load %

If you don't know what those are, the basic idea is that the front end load is a percentage that is deducted as a fee when you buy the fund (if you invest $1000 into a fund that has a 5% front end load, then $50 comes off the top and $950 actually gets invested). The deferred load is the same idea only it comes out when you sell the investment.

What do I look for? I look for funds that have no loads. There are lots of funds out there that don't charge loads and I have yet to come up with a compelling reason to pay them.

Expense Ratio %

The expense ratio is the percentage of the funds assets that go to administrative fees. What should you look for? Look for funds that have low expense ratios. What should you consider too high? Well I'd look very carefully at any fund that has an expense ratio that is greater than 1%. If the expense ratio is high it better be performing much better than similar funds otherwise I see no point to paying the added expense.

Morningstar Rating

This is how much Morningstar likes the fund. The best rating is 5 stars. Even though Morningstar is not necessarily the final word on funds, I'd look closely at funds that Morningstar doesn't at least rate at 3 stars (they have a detailed description of how they arrive at their rating on their page).

Performance Graph

I really like the graph because it shows the performance of the fund vs. the category of funds in general. If the fund consistently performance below its category I view that as a sign that it isn't a very good fund.

Morningstar Risk

This is just Morningstar's characterization of how risky the fund is (on their page they have the full description of how they determine their risk rating so I won't repeat it here). Looking at this field gives you a quick way to determine if a fund meets your risk tolerance.

When I'm evaluating a fund one of the first things I do is go to Morningstar and see how it looks. I can quickly get an idea on the loads and expenses for the fund, as well as its performance and risk. I can get all of the info I need to make a first glance judgement on a fund on a single page for free!