U.S. Investors Save $5.5 Billion In Fund Fees, But Some Are Overlooking This Other Big Expense

U.S. investors are focused on expenses more than ever.

Index funds and exchange traded funds (ETFs) have saved investors a lot of money. But the same investors looking for the cheapest funds also need to think carefully about how much they’re paying their investment advisers.

According to Morningstar’s annual study, released Monday, the asset-weighted average expense ratio for all U.S. mutual funds and ETFs declined to 0.48% in 2018 from 0.51% in 2017, leading to estimated savings of $5.5 billion.

That’s an eye-popping figure. It’s no wonder that Fidelity Investments considers its traditional business model to be “broken.” Then again, Fidelity is now part of the index revolution, even going so far last year as introducing two index funds with no expenses at all in August and two more in September.

The movement of money to passive index funds and ETFs from actively managed funds is nothing new. Active managers are trying to be more competitive, having lowered their asset-weighted average expense ratio to 0.67% in 2018 from 0.71% in 2017, which Morningstar said was the largest decline on record since the financial-information company began compiling the data in 2000. Then again: “The average active fund still charges about 1.8 times as much as the average passive fund,” according to the report.

Accelerating decline in fees

Here are some more fascinating statistics from Morningstar’s annual fee study:

• The weighted average expense ratio of 0.48% for 2018 is down from 0.93% in 2000.

• For passively managed funds (index funds and most ETFs), the asset-weighed average expense ratio declined to 0.15% in 2018 from 0.16% in 2017. This may not seem like much of a drop, but it represents a 7% fee cut for the fund companies.

• Looking at the average expense ratio of 0.67% for actively managed funds and the 0.15% average expense ratios for passive funds, investors were paying 4.5 times as much for active management as they paid for passive management. Morningstar said this was “the widest gap between active and passive fund fees since we began tracking trends in asset-weighted average fees in 2000.”

• During 2018, the 20% of all U.S. funds with lowest expenses saw combined net inflows of $605 billion, while the remaining 80% saw combined outflows of $478 billion, which Morningstar said “was the largest-ever outflow from this cohort.”

Those flow numbers are astounding.

In an interview, Morningstar’s Ben Johnson, director of ETF and passive strategies research, said that when he and colleagues took an even closer look at the data for the 20% of funds with the lowest expenses, they saw that “the lion’s share went into the cheapest 10% of funds.”

“It is not that investors are being price-conscious; it is that they are being downright stingy,” he said.

What about your investment adviser?

The Morningstar study of fund fees made it clear that investors believe low expenses will lead to better performance. But the study didn’t include financial advisers’ fees, which average 1% of assets under management, according to more than one study.

The significant decline in fees cited by Morningstar “should prompt investors to ask pointed questions of their advisers,” Johnson said.

The financial-services industry continues to evolve, and passive money management is not the only earth-shaking trend. The traditional full-service brokerage model continues to be eroded as low-cost “financial supermarkets,” including Charles Schwab SCHW, -0.26% Fidelity, E-Trade ETFC, -1.19% TD Ameritrade AMTD, -0.59%  and others, gain in popularity. Traditional brokers have been moving to the advisory model, where clients pay an annual fee for all services, rather than paying commissions to buy or sell securities. The discount brokers are also offering different levels of advisory service, including lower-cost robo-advisers.

“It leaves one wondering as we see a shift in advice to fees from commissions — it may effectively be just squeezing one end of the balloon and pushing all the air to the other side,” Johnson said.

Are you paying 1% annually to a financial adviser? If so, you need to keep in mind that this is a big fee, especially when compared with the mutual fund managers’ fees discussed above.

Imagine if you were a retired investor focused on maximizing current income. You would be hard-pressed to put together a portfolio (with the help of your adviser) with an average yield (not total return, current yield) of 5%. If you did, and your adviser was charging an annual fee of 1%, the adviser would be getting 20% of your income.

So if you’re paying an investment adviser, you need to find about all the services he or she can provide. You may find it worthwhile to pay for a variety of financial-planning and investment services. You may also be able to take advantage of sophisticated investment strategies recommended by your adviser, including this covered-call strategy described by Ken Roberts, an investment adviser with IWC Asset Management in Carmel, Calif.

A financial adviser can be helpful if you’re facing an important milestone, such as retirement or a home purchase. They can tailor specific investment strategies based on your goals and tax situation.

Read: These are the 3 big reasons you should use a financial adviser (and picking investments is not one of them)

So if you’re working with an adviser, try to get the most out of the service and discuss the fees — after all, they are negotiable.

Don’t miss: This overlooked group of stocks can give you better returns with less risk over time

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