Every April 15 when I write that painful check to the IRS, I console myself with the reminder that having tax-generating income is certainly better than not owing anything at all. Assuming I don't incur underpayment penalties, it's also better than having had the amount surreptitiously extracted from a paycheck; I've gotten to put that money to use for me and my family for as long as possible.
Still, writing that obvious check hurts, every time.
This year, I realized that transparent investment costs are like that too. Investors should significantly prefer fees and costs they can clearly see instead of insidious, opaque costs that they can't. When as many costs as possible are front and center, you can more readily compare them to others and determine if you're getting what you're paying for versus being gotten.
To name a few examples of hidden costs many investors face unawares, there are:
- Undisclosed incentives paid to a broker for recommending one product over another.
- Bond transaction markups or markdowns, which represent the difference between the "wholesale" price a bond broker pays and the "retail" price you incur.
- Trading costs such as market movement costs and bid-ask spreads that tend to play against impatient traders who are anxious to buy or sell, particularly in large lots; the market senses the impatience and drives pricing in the opposite direction.
These costs don't show up in any "bill" or financial statement you receive; they are hidden inside diminished share value on your holdings. But they are nevertheless real drags on your end returns, literally and figuratively.
- Our fiduciary adviser fees show up loud and clear on clients' financial statements.
- The low-cost funds in which clients typically invest publish their expense ratios in their prospectuses.
- The custodians where clients' accounts are held further disclose any transaction fees incurred as we build and manage their portfolio.
As a fiduciary adviser, I also am obligated to always act in my clients' highest financial interest, which includes aggressively minimizing those aforementioned insidious costs. To ensure I am best positioned for this role, I maintain a fee-only practice, which means none of any hidden costs that must remain end up in my pocket; my only source of compensation is those clearly disclosed advisor fees.
Which returns me to my statement above. As an investor, you should prefer operating in an environment in which you can see and assess the various fees you are incurring – as many of them as possible. Unfortunately, in reality, while hidden fees can readily cost you considerably more, when they are out of sight, it's easier for them to be out of mind.
Bottom line, whether it's your taxes or your investments, there are rarely free lunches to be found. Hidden costs, may not hurt as obviously, but they're every bit as painful to your wallet and considerably harder to eliminate.