Last week, my mom pulled out her 401(k) statements and asked whether she was paying too much in yearly fees.
What I found surprised her. In fact, it made her consider serious changes to her financial plan. Sadly, I wasn't surprised at all by what we uncovered. It's a problem all too common in the financial industry: your advisor posing the biggest threat to your wealth.
I like to take the "before tax" number and compare it to the benchmark index returns -- this gives a more apples-to-apples comparison. In my mom's case, the fund she was invested in was an all-equity fund. The 10-year before-tax returns were 8.71%. The average returns of the index -- in this case, the CRSP US Total Market Index -- were 8.62%.
On the face of it, you might say: "Well, she's getting her money's worth. Her fund is beating the index by 0.09 percentage points." But we're missing one step that makes all the difference in the world.
You need to calculate this crucial figure on your own. Take the average returns of the fund and subtract whatever fees you're paying (unless, of course, your fund makes clear that returns are "after fees"). Then you get a much better picture of what's going on. For my mom, it looks like this:
Again, this might not seem like too big of a deal. A return of about 7.6% isn't bad at all, and it's only about 1 percentage point behind the benchmark index. But what if there were a cheaper alternative that mimicked the index's returns? Vanguard, for instance, offers the Vanguard Total Stock Market ETF , which does just that. The fees on this investment, however, are just 0.05%.
Therefore, even though the Vanguard investment's returns aren't quite as good as my mom's mutual fund, it earns investors more money in the end. The math is pretty simple:
Still, you might not be convinced that the difference between these two numbers is very significant. After all, what's a percentage point here or there?
Well, if you were to invest $10,000 today, here's how the money would grow over 45 years (the span of the average career). If you're wondering what the difference is over shorter time frames, simply hover over the graph to see.
That single percentage point meant that the Vanguard fund had 50% more money in it at the end. That's an enormous difference.
So why do advisors push us toward bad investments?
There are lots of reasons a financial advisor might convince you to choose a fund with high fees. He or she may genuinely believe that the fund will outperform the index, even after fees. If that's the case, ask for the proof.
Far more often, however, advisors are incentivized to usher you toward certain funds. One of the fees that mutual funds will charge you is called a 12b-1 fee. Ostensibly, these are monies taken from your account to pay for "marketing." But a rather insidious way these fees can be used is to reimburse advisors who bring clients to the fund.
In other words, putting your money in high-fee funds is often good for the advisor -- not for you.
How can you find a reliable advisor?
The good news is there are a few easy ways to find an advisor who would never do such a thing. Most importantly, find an adviser who has taken a fiduciary oath -- which means they are bound to put your best financial interests first.
Usually, these advisors charge a flat fee -- instead of a percentage of assets or a commission -- as a way to ensure that there's no added incentive for them to steer you toward investments that aren't the best for you.
The truth is that there are as many wonderful financial advisors out there as there are bad ones. I believe the best place to start looking is the National Association of Personal Financial Advisers -- a group of advisors who are fiduciaries who charge flat fees. Once you find one you're comfortable with, you can rest assured that they are not a threat to your wealth -- quite the opposite, in fact.
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The article Your Financial Advisor May Be the Biggest Threat to Your Wealth originally appeared on Fool.com.
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