Quizmaster Doug Hutchinson has come up with another great quiz that explores advisor fees and mutual fund expenses to consider when choosing an advisor. Let’s see what the math has to say.
Consider the following scenario:
Sam, Frank, and Kathy use different financial advisors. Each financial advisor has a different fee structure.
Sam pays a flat fee of 1% to his advisor. There are no other fees associated with his account.
Frank pays his advisor a fee of 0.9%. The advisor invests Frank's assets in a mutual fund with an expense ratio of 1.6%.
Kathy pays her advisor a flat fee of 0.75%. Her advisor invests Kathy's assets in a mutual fund with an expense ratio of 1.25%.
Assume:
- An annual return of 7% (before fees and expense ratios are taken into consideration) per year for each of the next 3 years for Sam, Frank, and Kathy.
- Sam, Frank, and Kathy start Year 1 with $100,000.
- Fees are deducted directly from each account.
- Advisor fees are charged annually and are applied after mutual fund expenses are taken into consideration.
After 3 years what will be the value of each of their accounts after all fees and expenses have been taken into consideration?
Solution: For each year - multiply the starting value by 1.07 to capture the return and then multiply that number by 1 less the fee amount to capture the effect of fees.
Sam:
Sam's fee is straightforward at 1%.
Year 1: $100,000 x 1.07 x 0.99 = $105,930
Year 2: $105,930 x 1.07 x 0.99 = $112,211
Year 3: $112,211 x 1.07 x 0.99 = $118,865
Frank:
Frank's mutual fund has an expense ratio of 1.60% and he would then pay his advisor 0.9% of the value of his mutual fund (net of expenses) annually.
Year 1: $100,000 x 1.07 x 0.984 x 0.991= $104,340
Year 2: $104,340 x 1.07 x 0.984 x 0.991 = $108,869
Year 3: $108,869 x 1.07 x 0.984 x 0.991 = $113,594
Kathy:
Kathy's mutual fund has an expense ratio of 1.25% and she would then pay her advisor 0.75% of the value of her mutual fund (net of expenses) annually.
Year 1: $100,000 x 1.07 x0.9875 x 0.9925 = $104,870
Year 2: $104,870 x 1.07 x 0.9875 x 0.9925 = $109,977
Year 3: $109,977 x 1.07 x 0.9875 x 0.9925 = $115,333
The extra layers of expenses and fees that Frank and Kathy are paying through their mutual funds have proven to be extremely costly. After 3 years Frank has accumulated $5,271 LESS than Sam. After 3 years Kathy has accumulated $3,532 LESS than Sam.
* Note that this difference in wealth accumulation compounds over time. After 10 years of annual returns at 7% and the same fee structure as above, Sam will have accumulated about $25,000 MORE than Frank and about $17,000 MORE than Kathy.
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This quiz is intended for informational and illustrative purposes only. This material is not intended to be relied on as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The information presented is general information that does not take into account your individual circumstances, financial situation or needs, nor does it present a personalized recommendation to you. The information and opinions contained in this material are derived from sources deemed reliable, are not all-inclusive and are not guaranteed as to accuracy.
