Investors pay their managers a fee according to their contract. Assets managed, multiplied by the predetermined fee is the cost of investment advice. Case Closed, right?
Depending on the placement of investments, there may be a “Layering of Fees”. If the Investment Manager uses additional funds or groupings of assets for investment, the managers of those funds are likely charging fees as well. This addition of fees can result in a sizeable drag on investment returns, and be out of line with expectations based on the immediate client contract.
For example, an investment manager might offer a portfolio of exchange-traded funds (ETFs) or mutual funds. In that scenario, the investor pays fees not only for the investment manager but also for the securities held within the portfolio.
Investors try to avoid paying layered fees because they effectively entail paying twice for the management of the same assets. Layered fees can easily add up, dragging down investment returns.
To protect investors, any product that charges layered fees must disclose those fees in the product’s prospectus. This is one of the reasons why it is essential for investors to carefully review the prospectus of any investment they are considering.
Depending on the structure of the investment product in question, investors may have to comb through the prospectus documents carefully to determine its true costs. This is because fees can be presented in many different forms, including asset management fees, commissions, transaction fees, and other fees designed to cover operating expenses.
Although investors generally avoid layered fees, they may sometimes be justified. Investors should consider paying layered fees in situations where the investment manager clearly adds value, such as when the assets within the portfolio are very complex. For example, if the portfolio includes investments in foreign companies, the added complexity of evaluating those securities may justify paying a layered fee.
Real-World Example of Layered Fees
Emma wishes to gain exposure to foreign stocks in her portfolio. She does not have the time to diligently research foreign stocks herself, so she chooses to invest in an active investment fund instead.
The fund she chooses, XYZ International Equities, has a layered fee structure. Specifically, the fund has a 2% management fee and holds a basket of international ETFs. On average, those ETFs have their own fees which work out to roughly an additional 0.75% annually. Therefore, Emma knows that if she invests in XYZ, she will need to earn at least 2.75% per year to make up the cost of its fees.
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