Rule #6: Most people are trying to sell you something.

I tell you this from experience: everyone, especially in finance, is trying to make money. Any business involved in the minutiae and grind of helping people with their money needs their cut. With banks, this comes in the form of net interest rate spread. This amount is the difference between what a bank gives in interest to account holders, and what they charge on loans. Bank ABC has an average savings account interest rate of 1.5%. Bank ABC also charges an average of 4% interest on their loans. Therefore, Bank ABC has a net interest rate spread of 2.5%.

Financial institutions are critical to our economy, providing global capital markets with the required transacting ability to spur investment and grow GDP. As a consumer and financially savvy young person, you must understand this. Robinhood, the notorious iPhone stock trading app, says its trades are free. And in the literal sense, they are. Robinhood makes money by bundling your orders for stock with those of your neighbors, siblings – even your grandma and grandpa. They then sell these bundled orders at a better execution price and keep the difference. This one is called payment for order flow. Maybe you don’t care about that – you just like your free trades. There is also Coinbase, which charges a transaction fee on sending, receiving, buying, or selling Bitcoin. And what about real estate brokers and agents, who have commissions on the purchase or sale of properties? There are also insurance agents, who receive a commission on every policy they sell. ETF and Mutual Fund companies charge management and other fees in the form of an expense ratio. However you slice it, my point is this: There’s no such thing as a free lunch. And even if there were, it would definitely not be in finance.

I’m not saying that fees are bad. Without them, these large institutions wouldn’t be able to provide us with their services and keep the financial system running smoothly. I am saying, though, that you have to do your research. This is your money after all, and you want to know exactly where it’s going. Some fees are reasonable and can be accepted for the level of service and technology a company may provide to you. Other fees, however, are less helpful, and often hidden by smooth-talking bankers, real estate associates, investment advisors, and insurance agents. In the long run, these fees can be detrimental to your financial health. I will give an example from one of my clients and her previous financial advisor.

This client had been speaking about her accounts for a while. She liked the financial professional she was working with and had little worries about her financial position and how things were being handled. She was the kind of person who wanted to be “hands off” with her finances, letting her advisor do what they thought best. There is nothing wrong with this in itself, but coupled with a financial professional using the client’s inattention to sneak in high fees, it was a recipe for very poor investment results. I inquired more, and just as I thought, this was exactly what was going on.

The financial advisor had a third-party arrangement with a mutual fund company and was receiving compensation for putting the client into funds sold by this company. The funds also had something called a “load fee,” which is charged to the client when purchasing the mutual fund for the first time. Load fees are often high, and in the age of ETFs and lower-fee mutual funds, are often quite unnecessary. In the case of my client, the mutual funds had a 6% load fee. On a $100,000 investment, the client would pay $6,000 in fees – before the investing even started. This sets them back 6% before they even start, and is a quintessential example of a bad – even evil or predatory – fee.

Not only did these funds have load fees, but they also had expense ratios. Expense ratios are a percentage of the fund taken from investors each year in order to pay for operating costs (things like portfolio managers’ salaries, registration fees, and marketing/licensing). Expense ratios are commonplace in all types of investment vehicles. They vary based on the investment product or fund offered. It is estimated that most passively managed funds have an expense ratio of .20% or 1/5th of a percent.^[1] Expense ratios are one of those necessary fees to offer investment products that are safe and highly professional. However, as these fees subtract from the value of your funds, less is better in most situations. My client’s average expense ratio was just about .80%, four times the industry average – another unnecessarily high fee. Finally, the financial advisor also charged an AUM management fee. This is similar to how I am paid in my practice, and I would argue is the best, most client-aligned way to bill in our industry. This fee was .40%, relatively low as far as AUM fees go. Putting it all together, this client would be charged 7.2% of total fees in her first year of investing. The remaining years would carry an annual fee of 1.2%. Over the life of an investment portfolio, this is incredibly significant. The loaded mutual fund fees made her lose a whole year’s return before the year even began. No good. I will give a few more examples from my own experience, and from the stories of other folks that I have amassed over the years. Then, we will make a list of questions to ask any financial professional you work with, from a banker to a real estate agent, that will help you intuitively avoid most detrimental fees.

Bank account fees are a huge one. Many banks, believe it or not, charge a monthly fee as part of your statement. There’s really no need for this, considering you’re already giving them your money. We know from the net interest rate spread, that the bank will be making a significant amount of money on the money you provide them. Many banks have adapted to this way of thinking, and have recently decided to offer zero-fee, truly free accounts. You should take advantage of this. Many financial technology companies also provide free banking services, fully digital. While it is not the traditional method, it is possible to create a bank account within your Venmo or Cashapp. Banks will also charge fees on other things if you are in the wrong type of account. This can come from ACH transfers, overdrafts, and inactivity. Finding an account that has the best balance of features you need, at the cheapest rate possible, is critical. It is okay to settle for a few fees – as we’ve said, they are necessary to keep the institutions running. Make sure you take a quick look at what the account is giving you versus what it is charging. Close it and find another if there are any discrepancies.

Investment account fees are another big one you may not know you are paying. While less common in self-directed accounts, many companies that issue investment services may have transaction or account fees. These fees could be an annual amount, a certain percentage, or even a fee per trade placed. While it is common amongst trade for free apps, most 401k and institutional retirement providers will still ding you for making trades. For less liquid markets, like real estate or cryptocurrencies, there may also be per-trade transaction fees. If this is the case, make an effort to trade less and save money, each fee you pay comes directly from your investment returns. Fees could also be charged on a percentage of your assets under management. We touched a bit on this prior but for the industry as a whole, this fee averages out to 1%, anything above that should be a glaring warning sign. Mutual funds held in accounts might not directly charge fees above that of their expense ratios but have hidden fees in the form of their tax structure. Unlike ETFs, mutual funds do not have a fixed share count, thus the funds’ manager must sell investments if shareholders choose to redeem or “cash in”. In this case, investors who are still invested in the fund will be subject to capital gains taxes, regardless of if they wanted them or not. An ETF on the other hand has its value derived strictly from the market price and allows the investor to choose when their capital gains will be distributed. For this reason, a portfolio of mutual funds over the long run will greatly underperform an ETF when adjusting for tax implications, another hidden fee.

Speaking of taxes, for many investors the biggest fee they will incur when investing (assuming they make a profit) will be their tax bill. We already spoke on the types of capital gains taxes and Tax-Loss Harvesting, but I’d like to take it a step further. When making an investment or money decision, one should always have the assumption that uncle sam is entitled to 10%-30% of any money made. That is the biggest “hidden” fee involved in the investment process. As a rule of thumb, the more you make salary or income-wise, the more you must actively consider your tax implications financially. Here’s an example from a client of mine. This person was government employed and had been so for many years. The nice thing about being government employed is the retirement benefits. Most government employees are entitled to what is known as a Pension. Pensions used to exist all over the private sector but after a few notable blow-ups, it become apparent that retirees were screwed if the employer couldn’t make good on their commitments. These commitments were funded by investment returns and thus if returns were poor, retirees weren’t given their money. No good. The government is still able to offer these programs today however because if the investment returns fall short, they are able to get emergency funding from the central bank or treasury.

My client was nearing retirement and thus was making the best money of her career. Furthermore, due to her tenured history and service, she was granted a large pension and adequate social security checks. She was going to make more in retirement than she did working. From an outside perspective, this seems like a nice problem to have, and indeed it is. However, my client was also leaving a fair amount of money on the table in a hidden way based on how she was contributing to her non-pension retirement savings. Given she was expected to make more in retirement, contributing to a traditional IRA was sub-optimal i.e. the deferred tax break received now would be taxed at a higher rate when the money came back out during retirement. What made more sense was to pay the taxes on the investment now, by investing in a Roth IRA which could be taken out tax-free during retirement. Furthermore, the client had ample cushion to not touch that Roth IRA investment and could theoretically allow it to grow until late in her golden years, effectively saving thousands, if not tens of thousands, on taxes. Not optimizing for tax situations might be your biggest hidden fee.

Some questions for financial professionals

How are you getting paid for this?

You would be quite surprised at what folks will tell you if you ask them about how the products or services pay them. In much of the investment industry, it is actually standard practice to disclose these things. So if a professional is iffy about explaining this, they aren’t someone you should be working with.

Do you or your company have any behind-the-scenes arrangements that will pertain to the money I have here today?

Sometimes the fees won’t come from the professionals themselves. It is even more likely that it will come from a third party. It is important to ask these questions to uncover fees. Even if there aren’t any, you will be made aware of any agreements that could impede your goals.

Can you provide me with a reasonable estimate of what (in dollar terms) my fees could be if we decide to move forward?

Most folks should be able to do this for you. If they can’t, or it seems unreasonable, that is a good sign to stay away.

Can I expect what you have told me here to remain constant throughout the life of our work together?

This is another good one. Sometimes programs will have intro prices or rates that are stated unclearly. If you are aware of the fact that your fees may go up, it could dissuade you from taking that particular option in light of a cheaper one.

What do you charge others doing the same thing as me?

I like to think that if someone is offering you a “special” rate, or something of that sort, it is much more likely that predatory fees will be involved. Look for a clear, reliable fee schedule and strategy for all clients.

How do you handle these matters for yourself?

You could also ask the professional how they handle the same financial situation for themselves. If they give a reasonable and similar strategy to what you both are hoping to do today, that is a good sign.

What is your experience in this line of work?

Asking about experience will always help weed out salespeople. Often, “sellers” don’t have the experience that reputable folks do, and they have a harder time coming up with a story. Someone who can tell you about all their experience, accolades, and history confidently and concisely is someone who should be worked with.

Do you have sales goals or quotas that you must meet or are incentivized to meet?

Direct and informed, this question will shake even the best of the smooth talkers. In the case of certain industries, sales quotas are standard practice, and asking why is another usable question.

Who would we contact if we ran into issues or had a misunderstanding?

It is always good to be knowledgeable of what the worst case may be (more on this in the next section). No financial professional has all the answers, and an honest one will tell you where you’d both go in the event of an unplanned occurrence.

Do you think we are a good fit to work together?

This might be the most important question. There are many different financial professionals that service many different niches. If you aren’t sure of whether or not this one fits with you and your goals, it is best to ask. A good financial professional will tell you honestly why it may or may not work, and if not, refer you to someone who would be a better fit. Beware of someone who works with anyone and everyone, and doesn’t seem to have a client demographic or ideal customer.

While this list is in no way exhaustive, it is a good starting point. The important idea is to ask questions and investigate what happens within the companies and professionals that help you with your money. It is often the case that those who do not investigate and ask questions are subject to unnecessarily high fees and hidden costs. Most people are trying to sell you something.