- Why is a stock broker often a poor source of investment advice?
A broker is compensated by the number and size of trades a client makes. This means he has a bias toward a lot of in and out rather than stable return at low cost.
- What costs are necessary to support any securities investment?
The minimum costs involve a brokerage commission for the purchase or sale of stocks or derivatives and the spread between the bid price and the ask price of any security. These should total around 50bp but are often more than 1%. Most brokers do not charge explicitly for holding securities in custody, as a result. If one is investing through a fund, the minimum additional charges are for custody and fund administration, annual audit and fund registration or licensing. These should range between 25bp and 100bp. Manager's fees on top of that, as a flat % of the assets under management, usually range between 10bp for an equity index fund up to 150bp for an actively managed balanced fund in emerging markets.
- What costs are normally (including the unnecessary) associated with investment funds?
In addition to imbedded brokerage commissions (at 50bp or more), bid-ask spreads (of as much as 1% the mid-price), custodial, audit and administration expenses, plus management fees, many funds charge sales fees or exit fees. These additional fees (also known as "loads" because of how they add additional drag on the client's performance) can be as high as 5% of the amount invested. The sales fees are used to pay for someone to talk you into buying the fund; whereas, the exit fees are meant to discourage clients trading in and out of the fund too quickly. At a low level (below 1%), there can be an argument (admittedly a weak one) for either.
- What level of fees is reasonable for investment advice (either with discretion or as sub-advice alone)?
So long as the manager can produce consistent, fairly stable returns in excess of the agreed benchmark (whether that be deposit rates for "absolute-return" funds, or a hybrid of market indices for active and passive funds), 5% of the expected return tends to be a standard for very conservative funds and 7-10% for high-performance funds. That translates into 40bp to 100bp in annual fees. No more than 1% of the amount managed. Thus, a "performance fee" is an entirely new idea that encourages the manager to be "aggressive" taking considerable risks, with a very short-term performance target. Some clients want that, but most (if properly informed of the consequences) do not.