Investors don’t understand the fees they pay for investment products and advice especially well, according to a recent State Street Global Advisors survey.
State Street’s Low-Cost Investing Survey found a general lack of understanding when it comes to the management costs and advisory fees that investors pay. In fact, only 17% of investors who participated in the online survey knew that management costs associated with mutual funds and exchange-traded funds (ETFs) are separate from the fees that financial advisors and investment platforms charge.
The survey, which was conducted in June in partnership with A2B Planning and Prodege, collected data from 224 adults with at least $250,000 in investable assets.
What Are Expense Ratios and Basis Points?
While 87% of investors said they are at least “aware” of the term expense ratio, only 30% said they completely understand what an expense ratio is. Likewise, 83% of investors reported being aware of basis points, but only 25% said they completely understand them.
So what do these terms mean and why are they important to understand?
An expense ratio is the percentage that a manager of a mutual fund or ETF charges to cover various costs associated with running the fund, like management, marketing and recordkeeping fees. Those fees are bundled into a ratio that is expressed as a percentage of an investor’s total assets with the fund and automatically removed from their account each year.
The smaller the expense ratio, the more money an investor keeps to him or herself. Meanwhile, a heftier expense ratio can significantly eat into future returns.
A basis point, on the other hand, is simply equal to one one-hundredth of a percent, or 0.01%. This means if an expense ratio is 0.5%, the fund charges 50 basis points. Financial advisors and traders use this term for several reasons, but primarily because it’s a quick way to communicate important information. Shortening the phrase “one one-hundredth of a percentage point” to “basis point” makes for easier and more direct conversations.
Advisory Fees vs. Fund Management Fees
It’s clear that much remains unclear when it comes to advisory fees and fund management costs. According to the State Street survey, nearly half of investors (47%) believe the fees they pay their financial advisors or investment platforms cover the management costs (expense ratios) that mutual fund and ETF companies charge for their products. In fact, only 17% correctly said advisory fees do not cover the expense ratios of mutual funds and ETFs.
While financial advisors typically charge an asset-based fee for their services, this fee does not cover the cost of investing in particular funds. Like expense ratios, asset-based fees are usually expressed as a percentage of assets in a portfolio, but they go directly to your advisor.
By not understanding the distinction between an advisory fee and fund expense ratio, an investor may overestimate their expected returns.
What Constitutes “Low Cost?”
The survey also found that investors are generally unclear about what constitutes a low-cost fund.
Investors who said they understand expense ratios and/or basis points consider funds with expense ratios of 0.60% or less to be low cost. However, State Street Global Advisors noted the asset-weighted average expense ratio of U.S. open-end mutual funds and ETFs are 0.51% and 0.20%, respectively. This signals that investors may be in funds that they incorrectly deem to be low cost.
“From an ETF provider’s perspective, low cost is generally considered funds with an expense ratio of 0.10% or less – this is 6x lower than the threshold of investors in the survey,” said Brie Williams, head of practice management at State Street Global Advisor. “The bottom line is, when all other variables are equal, lower cost investments can help investors keep more of what they earn in their portfolio.”
The State Street Global Advisors’ survey shows that a large percentage of investors remain hazy on the fees they pay. Nearly half of the people polled said they thought fund management fees (expense ratios) were included in the advisory fees they pay their financial advisors. Meanwhile, only a small percentage of investors fully understand what expense ratios and basis points are, the survey found. There is also confusion surrounding what constitutes a low-cost fund. While investors believe 0.60% is the low-cost threshold, the average expense ratios of mutual funds and ETFs is actually less.
Tips for Finding a Financial Advisor
- Need help finding a financial advisor? SmartAsset’s free matching tool can pair you with fiduciary advisors in your area in as little as five minutes. If you’re ready to be matched with local advisors, get started now.
- Don’t automatically hire the first advisor you meet. Make sure you shop around and speak with at least three advisors. You’ll want to take into account their professional certifications, their fees, whether they have any regulatory disclosures on their records and whether you can see yourself working with them.
- Understand the difference between fee-only and fee-based advisors. Fee-only advisors earn money solely from the advisory fees their clients pay. Fee-based professionals, on the other hand, earn commissions for recommending insurance policies and/or investment products, in addition to the advisory fees that clients pay. This can create a conflict of interest, so fee-only advisors are typically preferable.
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