Some costs may be unavoidable if you want to make a change or follow your preferred advisor to a new firm; however, you can take some proactive steps with your advisor to mitigate or eliminate the costs of moving your assets.
Switching advisors or investment firms almost always results in changes to your portfolio holdings. Given that we’ve experienced a bull market for more than eight years, these changes will result in taxes owed on the capital gains generated.
In taxable accounts, any gains you realize on assets held for one year or less are taxed as ordinary income. Assets held in taxable accounts for more than one year are subject to capital gains tax.
The long-term capital gains rate is 15% for married couples filing jointly with taxable earnings between $75,900 and $470,700. The rate is 20% for couples filing jointly with taxable earnings above $470,700.
In addition, nearly all investors will pay state income taxes on capital gains. Couples filing jointing and earning over $250,000 will pay a 3.8% Net Investment Tax, too.
If you are in the top income tax bracket and move your $1,000,000 portfolio with $100,000 in long-term capital gains to a new firm that recommends selling all or part of it, that triggers a big tax expense for you. You could owe up to $23,8000 in capital gains (plus state taxes!) if they suggest selling all your existing holdings. If you have short-term capital gains, the cost would be even more.
Prior to hiring a new financial advisor, understand the tax implications of proposed changes to your portfolio. An advisor with your best interest in mind should make recommendations that minimize or eliminate tax consequences.
Your new advisor may want to purchase holdings that fit a new investment strategy for you. And while transaction fees are lower than ever, liquidating portions of your existing portfolio still adds up quickly.
Most people have multiple accounts, each with anywhere from a few to dozens of holdings. Let’s imagine you have two taxable accounts and two IRA accounts, each holding ten positions – or 40 positions in all. If the new advisor recommends liquidating all 40 positions and purchasing 40 new holdings to implement their investment strategy, you’ve suddenly made 80 transactions.
Trading costs vary depending on custodian and security type, but let’s assume you pay $10 per transaction. That means you’ll pay$800 to align with your new advisors investment strategy. If transaction fees cost $25, then you’ll owe a whopping $2,000 just to update your portfolio.
As a client of a new firm, ask to have transaction fees waived for the first 30 to 60 days while your advisor implements their investment strategy. Also ask for reimbursement on any fees related to changing custodians.
Surrender Charges and Backend Load
There are many products that incur fees when you sell them. Variable annuities tend to have surrender charges for selling out of the policy before a predetermined amount of time. These surrender charges usually decline each year you’re in a policy, but often start around 10%.
Some mutual funds also carry back-end loads. That’s a percentage of the fund value paid when the investor sells the mutual fund.
Let’s assume you own $50,000 of a mutual fund that comes with a 4% backload. Selling this fund means you will owe $2,000 to the mutual fund company. This fee is on top of any transaction fee or capital gains taxes you may incur.
This isn’t to say you shouldn’t sell positions with a surrender charge or back-end load. But your new advisor should recognize these fees and give a sound explanation of why you’re better off selling these products.
While investors are getting better about understanding the total cost of ongoing investment advice and fund management fees, I never hear anyone ask about the costs of changing advisors or following an existing advisor to a new firm. Always inquire about the above costs when you change advisors.