Wall Street: Pay to Play?

For years, asset managers have tried to convince investors that they need to pay experts to guide them through the ups and downs of investing. These payments have been in the form of commissions, asset fees and performance fees, among others. Traditionally, brokers received commissions on transactions as a cost of doing business. From my own experience as a young trader in the 1980's and 1990's, a typical $5,000 to $10,000 trade would cost around $40 to $60 using a full-service broker. However, with the advent of automated online trading, the cost of equity trading has dropped dramatically. In 2017, the average cost for an online trade is typically between $5 and $7 for most self-directed trades. This amounts to roughly a 90% reduction in the cost of transactions. Investors who are not comfortable managing their own assets can employ the services of professional asset managers. Asset managers deriving their fees predominantly from brokerage fees not only charge higher (full-service) commissions but can also be motivated to trade more frequently or even purchase loaded funds with higher upfront commissions in order to increase revenue. To combat this temptation of over-trading, investors can place their assets with asset managers who base their fees on the total amount of Assets Under Management (AUM). Most institutional asset managers offer an AUM fee structure with a stylized investment approach based upon the specific needs of the individual investor. AUM fees typically range from 0.25% to 1.5% depending upon the total AUM. AUM's less than $250,000 typically result in an annual fee totaling 1% to 1.5% of the managed assets. AUM's greater than $5,000,000 typically result in an annual fee totaling 0.25% to 0.75% of the managed assets. While AUM fees are fairly common, the main drawback is that no performance incentive is built into the fee structure. Considering that the majority of fund managers fail to beat the market averages, there is little justification to use an active fund manager purely for fund performance versus just investing in passive Index mutual funds with fees as low as 0.15%. CAUTION: Expense fees for S&P500 Index funds have ranged from 0.15% to 1.6% so choose your index fund carefully. During the 1990's, Hedge Funds flourished by offering targeted investment strategies with fees at least partially based upon performance. The typical Hedge Fund fee is comprised of an asset fee and a performance fee. Asset fees are typically 1.5% to 2% of AUM and performance fees are typically 15% to 20% of fund performance. While this fee structure does include an incentive to outperform the markets, the fund manager can still collect above-average AUM fees even if the Hedge Fund does not show a positive return. This relatively high fee structure necessitates that fund managers consistently outperform the market by a significant margin. Unfortunately, despite the initial success, Hedge Fund performance has been declining in recent years. In 2016, Bloomberg Gadfly reported that 10-year rolling returns for Hedge Funds have been consistently falling since 1999. This has led to an exodus from managed mutual funds and Hedge Funds into cheaper market index funds. As a result, these actively-managed funds have had to re-think their fee structure for the informed, cost-conscious investor. In summary, Hedge Fund returns peaked during the late 1990's and have been in steady decline ever since. The bottom line is that informed investors do have options available to reduce their fee exposure. High fees are not mandatory to play on Wall Street.

Submitted October 28, 2017 at 08:43PM by DTRS_Investing http://ift.tt/2yUPOSM