A huge number of investors do not invest in the stock market themselves but use the investment management service. The number of such people is gradually growing, and it will probably continue to increase. What is investment management?
This is an investment method in which transactions with the investor’s assets are carried out by a professional trustee. This service is often used by investors who do not want or cannot understand financial instruments, independently select shares of reliable companies, diversify their investment portfolio, and perform all the investing activities. They prefer to put it all in the hands of a manager.
People are also interested in such services as they are often prevented from accessing a wide range of exchange instruments due to their low qualifications status. Managers, on the other hand, have access to almost all securities. It is possible to entrust not only money to the manager, but also stocks, bonds, ETFs, and so on. Managers usually invest their clients’ money in deposits, stocks, shares, and bonds.
Moreover, investors benefit from professional portfolio management and an individual investment strategy. Only professional participants in the securities market with a license can provide investment management services. Such entities also need to comply with various laws and regulations.
Investment managers, obviously, do not do all of this work for free. Investors pay fees to be able to use their services. What are these? This is the topic of today’s article, so read on to find out what management fees are, different types of such fees, and other valuable information.
Management fees
If you have a financial advisor, it should be no surprise that you are paying that advisor a management fee. Management fees can often be hard to understand and although the percentages can seem small, the cost is significant. Yes, there are multiple services and many big companies that have free stock trading and so on, but if you need a little more guidance and hands-on financial advice, paying for it can be worthwhile.
Although what you receive in exchange for paying the management fees varies on a case by case basis, in general, your advisor would be coaching you through many financial topics, such as what type of accounts you should save to, how much you should save, what investments are the best choice for you personally.
Management fees are investment fees that are typically based on a percentage of funds under management. They are paid each year to the fund manager or financial advisor for knowledgeably managing your investment portfolio. The amount of help you need, the investment strategy, and the amount of assets you have are the main factors that determine how much you will pay in management fees.
The mutual fund expense ratio, which is one of the ways to pay the management fees, is an annual fee, so it compounds with your investment. Many mutual funds have expense ratios that are less than 0.25%, although they can range from 0.10% to more than 2%. Typically, the expense ratio will be lower with stock index funds and higher with bonds and international funds.
Financial advisors or fund managers typically send different offering documents that describe all the details of cooperation. This is where the investor can see how exactly this fee is charged to their account for each period, whether it is a month, or a quarter, or even a year.
Fee structures
There are several fee structures you might come across when looking for someone to help you manage your assets. Let’s go over the most widely used ones.
- Flat management fee. This is the simplest type of fee you will see. It is commonly used by mutual funds. The fee stays flat because no matter what you have in your portfolio, whether it is stocks or any other asset, or investment strategy you go for, it does not change.
- Asset class-based fee. This is the opposite type of fee. Some investment managers believe it would be fairer if they charge the fee based on what assets the investor has. Cash reserves, for instance, are charged a very low fee, which makes this fee structure attractive to value investors. Both investors and advisors benefit from such a fee structure.
- Tiered fee. Many companies encourage investors to invest more by offering a lower fee for a higher amount of funds in your portfolio. This strategy makes a lot of sense as it is advantageous for both sides: the investors get to pay less, while the advisors increase their earnings without inputting a significant amount of effort.
- Percentage-based fee. This is popular, although somewhat ridiculous model. In this case, the investor will be paying a fee that is equal to some percentage of the amount of assets in their portfolio. For instance, if you have a $50,000 portfolio, you pay a 1.5% fee, you will be paying $7,500, but if you have a $1,000,000 portfolio, you will be paying the advisor $150,000 a year. So, small portfolios are unattractive to the advisor, while investors with large portfolios might find better deals for the price an advisor would charge under this structure. After all, the service does not change proportionally to the amount of fee paid.
- Combined fee. In some cases, you might be charged a flat annual fee for the services and some additional fees if you have some specific assets in your portfolio, for example, or choose an aggressive investment strategy.
How to minimize management costs
Management fees might seem like a pretty insignificant part of investing. After all, what is a few percentage points off of an annual return? However, you will be surprised by the amounts investors pay the financial advisors or mutual funds. Although it is hard to avoid the cost of investing, there are ways to reduce the overall cost.
You can obviously search for investment services that offer the lowest rates. However, there is another strategy you can use. Look for managers who consistently outperform the indices in both positive and negative markets and actually earn their fees. Moreover, ensure that the manager you work with has plenty of experience working with assets you have in your portfolio.
Bottom line
The management fee is the charge that you will be charged to your account that is based on different variables. These factors can be different percentages for different assets or portfolio sizes. These percentages can be charged at different increments, whether it is the beginning or end of the month or quarter. Minimizing the amount you pay in management fees should be one of your investment priorities as they eat up your money a lot without you even realizing it. The returns you receive should justify the fees you pay.
