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Managing Custodial Fees for Investments: What Clients Should Know
What Are Custodial Fees?
Impact on Fees for Individual Investors
Rising Costs Across the Industry
Making Tradeoffs: Fees vs. Taxes
Evaluating ETF Options
The Advantage of DFA and Vanguard
Paper vs. E-Statements: A Cost Consideration
How We Help Clients Manage Costs at Axos Advisor Services
Three Key Takeaways for Investors
- Fee Structures Have Evolved:
Trading commissions have largely disappeared, but custodians are compensating by adjusting other fees. Understanding these shifts can help investors control overall costs. - Transparency and Competition Are Up:
Major fund providers such as Vanguard and Dimensional Fund Advisors (DFA) have never been publicly known to engage in cost-sharing with investment custodians. Fees are more transparent with these investment managers, but they also prompt custodians to seek revenue elsewhere. - Ongoing Investor Diligence Is Essential:
Even as expense ratios decline in many areas, rising custodial and service fees can erode returns. Working with your Aurelius Family Office (AFO) advisor, regularly reviewing investment products and fee structures can help enhance returns and preserve long-term gains.
Managing Custodial Fees for Investments: What Clients Should Know
Today, it seems like prices continue to rise for just about everything—whether it’s a homeowner’s insurance bill or a dozen eggs at the grocery store. The financial services industry is no exception, and custodial fees for investment management are increasing across the board. This article explains what custodial fees are, examines industry trends, discusses tradeoffs in investment decisions, and highlights how certain strategies—especially the use of ETFs—can help manage costs.
What Are Custodial Fees?
Our firm partners with Axos Advisor Services (Axos) and Interactive Brokers (IBKR) — both are custodians — to safeguard client assets. Axos and IBKR are responsible for essential functions such as processing trades, maintaining records, and generating account statements and tax reports. Currently, both Axos and IBKR only charge transaction fees on certain assets, as well as fees for paper statement and paper tax document production. Other investment custody firms have begun implementing these fees. Sometimes referred to as “safekeeping fees,” custodial fees cover the critical services mentioned and are typically deducted directly from client accounts.
These fees, along with other account-related charges, contribute to what is known as the total expense ratio. This ratio represents the overall cost of maintaining an investment account relative to the total assets held within it. Understanding these fees is important because they directly affect net investment returns over time.
Impact on Fees for Individual Investors
The evolution of the brokerage industry has significantly changed how fees are structured for individual investors. Two decades ago, many so-called “discount brokers” charged anywhere from $40 to $50 per trade, and fund companies often paid additional fees for platform visibility. Today, the industry has shifted, with many firms deriving a substantial portion of their revenue from other often less than transparent sources rather than traditional trading commissions. As a result, discount brokers have, in some respects, become part of the broader investment company establishment—an environment that some new entrants argue may perpetuate higher overall costs for investors in less transparent ways.
Despite these concerns, the general increase in market capitalization across various asset classes has contributed to lower fees for individual investors. Several factors account for this downward pressure on costs:
- Economies of Scale: As the total market size has expanded, fund managers can spread costs over a larger asset base. This may reduce expense ratios for funds and lower overall costs for investors.
- Declining Expense Ratios: According to data from the Investment Company Institute*, the average expense ratio for actively managed funds fell to 0.42% in 2023, while passive mutual funds averaged around 0.05%. These figures represent a significant drop from the 1990s, translating into meaningful savings for individual investors and enhancing returns over the long term.
- Increased Competition: As more participants enter the markets, competition among fund providers intensifies. This heightened competition exerts further downward pressure on fees, particularly in the realm of index funds and ETFs.
- Shift to No-Load Funds: A growing trend toward no-load share classes—often featuring below-average expense ratios—has also helped drive costs down. Between year-end 2010 and year-end 2023, the share of assets in index mutual funds and ETFs grew from 19% to 48% of all long-term mutual fund and ETF net assets, according to an Investment Company Institute report*.
- Technological Advancements: Technological innovations have improved trading efficiency, reducing transaction costs and further lowering the barriers to entry for both new investors and new fund providers.
- Investor Awareness: As more investors become educated about the importance of minimizing fees, providers face increasing pressure to offer competitive pricing.
Nevertheless, not all investors have a clear picture of the fees they pay. According to research from the FINRA Investor Education Foundation, over one in five investors (21%) do not believe they pay any fees at all, and 17% report not knowing how much they pay. This underscores the ongoing need for transparency and education regarding fee structures. Even though fees have generally decreased over time, remaining vigilant about costs is essential, as small percentage differences can significantly impact long-term returns—particularly in lower-yield market environments.
Another strategy employed by major discount brokerage firms involves using data analytics to track the annual revenue generated by each client account, a practice reminiscent of methods long employed by casinos to gauge gambler revenue. Accounts that produce substantial income for the firm, through frequent trades, higher transaction fees, or premium services—often receive additional attention. Conversely, those following a buy-and-hold strategy, relying on low-fee funds, or maintaining minimal cash balances may see reduced engagement. As a result, it can be prudent for investors to remain vigilant about how they interact with their brokerage firm and to consider strategies that minimize expenses in ways that align with their long-term objectives.
Rising Costs Across the Industry
In contrast to the long-term trend of declining expense ratios, certain areas of the financial services sector are experiencing fee increases. A recent Wall Street Journal report described how a custody representative advised a wealth management firm to increase its annual revenue by shifting client assets into higher-fee investments. Although this situation may have been unique, it highlights the broader pressures within the custodial industry to identify new revenue streams.
Industry cost structures are also undergoing significant changes, with relatively little public discussion about these shifts. Some fees are rising, partly due to decreases in the internal operating expenses of many funds. Additionally, heightened transparency means that investment fees for firms such as Vanguard and DFA—AFO’s primary investment management partners—do not involve cost-sharing agreements with custodians. As a result, many custodians no longer receive payments from fund companies or transaction fees on mutual fund trades. Since ETFs trade like stocks and generally have no associated trading fees, custodians often compensate for this revenue gap by adjusting other fees.
On a positive note, some major providers continue to reduce costs in other areas. Vanguard, for instance, announced a fee reduction across nearly half of its U.S. funds, projecting $350 million in savings for customers over the coming year. Actions like these underscore the importance of regularly assessing whether current investment options still meet cost-efficiency goals, given how quickly fee structures can evolve.
Making Tradeoffs: Fees vs. Taxes
To illustrate the tradeoffs investors sometimes face, consider the analogy of electricity costs and solar energy investments. In states where electricity costs are high—such as New Hampshire—many homeowners choose to invest significant capital upfront in solar panels. Despite modest state incentives, the long-term savings on energy bills often justify the initial expense. Conversely, in states with lower energy costs, such as Tennessee or Louisiana residents may have less motivation to install solar panels because the immediate cost savings do not appear as substantial.
This same principle can apply to investment management. For instance, imagine a client couple with a $6 million portfolio composed largely of mutual funds. If custodial fee structures shift, leading to higher ongoing costs, it may become advantageous to transition part of the portfolio to ETFs, which often feature lower fees and greater tax efficiency. However, substantial invested sums in the conversion of invested assets in mutual funds to ETFs could trigger capital gains taxes resulting in further significant taxes due in the short term. In contrast, maintaining existing mutual fund positions might result in paying a few hundred dollars per year in additional fees. Deciding whether to accept an immediate tax cost for potentially greater long-term savings requires a thorough evaluation of personal financial circumstances and investment goals.
Evaluating ETF Options
Exchange-Traded Funds (ETFs) have gained widespread acceptance among investors seeking cost-effective strategies. Several core attributes make ETFs particularly appealing:
- Lower Expense Ratios: Compared to many mutual funds, ETFs typically have lower annual operating expenses, which can translate into better net returns over time.
- Tax Efficiency: ETFs often incur fewer capital gains distributions because they employ in-kind redemption processes, minimizing taxable events.
- Liquidity and Flexibility: Traded throughout the day on major exchanges, ETFs provide intraday liquidity that can be advantageous for certain investment strategies.
The Advantage of DFA and Vanguard
Dimensional Fund Advisors (DFA) and the Vanguard family of funds offer both mutual funds and ETFs. DFA and Vanguard’s approaches emphasize diversified, low-turnover portfolios to minimize trading costs and reduce tax implications. By leveraging academic research and strategic trading practices, DFA aims to balance risk and return in a cost-effective manner. Vanguard has always been an industry leader and pioneer both in indexing strategies, and lower costs (see above commentary on recent cost reduction announcements by Vanguard).
For clients concerned about evolving fee structures, transitioning from DFA or Vanguard mutual funds to ETFs can be a way to reduce expenses over time. This is especially relevant when custodial fees increase or when a reallocation is already underway due to cash withdrawals, deposits, or broader portfolio rebalancing. However, any such decision must account for potential capital gains taxes and the client’s overall financial plan.
Paper vs. E-Statements: A Cost Consideration
Aside from custodial fees and product expense ratios, there are additional ways investors can optimize costs. One such area is the choice between paper statements and electronic statements (e-statements). Although paper statements provide a tangible record, they involve printing, postage, and handling expenses that may rise in the future.
E-statements offer several advantages, including reduced clutter, instant accessibility, and heightened security through encryption and password protection. Clients who opt for e-statements often find that it streamlines account management while contributing to an overall reduction in administrative fees.
| Feature | Paper Statements | E-Statements |
|---|---|---|
| Convenience | Requires physical storage | Accessible anytime, anywhere |
| Environmentally Friendly | Uses paper, which is less eco-friendly | Reduces paper waste |
| Security | Vulnerable to loss or theft | Encrypted and password-protected |
| Speed | May take days to arrive | Instant delivery |
| Cost | Involves printing and mailing expenses | No additional costs |
How We Help Clients Manage Costs at Axos Advisor Services
The role of an investment advisor is to guide clients through these evolving fee structures and help them make informed decisions aimed at maximizing after-tax returns for a given level of risk. Our firm focuses on evaluating tradeoffs and implementing cost-effective strategies across each client’s portfolio. Key areas of assistance include:
- Paper Statement Fee Change: Axos, one of the custodians used by our firm, will be charging $5 per account statement per month. To avoid this fee, clients are encouraged to switch to e-statements. Although regulations prevent our firm from making this change on a client’s behalf, we offer detailed guidance to simplify the transition.
- DFA Mutual Fund Fees: Axos will also be charging $10 per quarter for each DFA or Vanguard mutual fund held. Over time, as accounts are periodically rebalanced, our goal is to replace DFA or Vanguard mutual funds with their ETF equivalents where appropriate. This strategy can help reduce ongoing fees and improve tax efficiency, though it must be carefully weighed against any potential capital gains.
- Cash Withdrawal Guidance: Overnight delivery and wire fees can add up quickly. Our client services team works with clients to plan withdrawals in advance and, when possible, avoid last-minute requests that incur additional charges.
In Summary
Custodial fees represent one piece of a larger cost puzzle in investment management. While industry-wide trends show that expense ratios for many funds have declined significantly, certain custodial and service fees are on the rise. Clients therefore benefit from periodically reviewing their portfolios to ensure that their chosen investments align with both their risk tolerance and their cost-management goals.
ETFs, particularly those offered by DFA and Vanguard, can serve as an effective solution for reducing fees and improving tax efficiency. However, transitioning from mutual funds to ETFs may involve short-term costs, such as capital gains taxes. Similar to deciding whether to invest in solar panels for long-term energy savings, investors must consider their personal circumstances and weigh the potential benefits against immediate expenses.
Ultimately, the objective is to position each portfolio for sustainable, long-term growth while minimizing unnecessary costs. Through careful evaluation of custodial fee structures, thoughtful consideration of ETF strategies, and clear communication about statement delivery and withdrawal methods, clients can better navigate the evolving financial landscape. For those seeking further guidance, our firm stands ready to provide support, ensuring that cost-related decisions align with broader financial goals and risk parameters.
* “Trends in the Expenses and Fees of Funds 2023”, MARCH 2024 // VOL. 30, NO. 2, Investment Company Institute
Disclosures
Aurelius Family Office, LLC (AFO) is registered as an investment adviser with the SEC and Noticed Filed with the state(s) where it transacts business, unless excluded or exempted from filing requirements. This communication is for information purposes only, and it is not intended to provide specific legal, tax, or other professional advice. Investments involve risk and unless otherwise stated, are not guaranteed. Although information has been obtained from sources deemed to be reliable, we make no guarantee as to the accuracy or completeness of this data. AFO shall not be liable for any errors or omissions, or for any actions taken in reliance thereon. Be sure to first consult with a qualified professional adviser before implementing any strategy discussed herein. Past performance is not indicative of future results.
