The enemy of winning long-term investment returns isn’t stock market dips. It’s fees.
Investment fees don’t simply deal you a single blow. They are a triple threat to your net worth:
- First is the upfront cost. You pay a percentage of your assets (the money you invest) to cover the fees. The money is immediately gone — poof — along with any opportunity to get invested on your behalf.
- Next, keep in mind that most of these fees you’ll pay aren’t one-offs. They’re recurring charges that continue to chip away at your portfolio balance year after year. (Poof, poof, poof ad nauseam.)
- Because the amount you pay in fees is based on a percentage of your assets, as your portfolio value grows, you’re paying more and more money, year after year. It’s negative compound interest at work.
Here’s the kicker: Many investors never realize how much they’re actually paying — or giving up in investment returns. It’s not like there’s a lot of fanfare — or even a billing statement to announce what you owe. Financial firms simply deduct investment fees from customer accounts automatically. Poof.
What’s the harm with paying a lousy 0.5%?
An alert from the Securities and Exchange Commission shows exactly how much an investor loses to fees over 20 years in a $100,000 portfolio that earns a 4% average annual return. The difference between paying 0.25% versus 0.5% in annual fees costs the investor $10,000 in returns over two decades. Earning a 4% return over 20 years and paying 1% in annual fees costs our account holder nearly $30,000.
Bottom line: Paying a 1% annual fee in the scenario above leaves you with around $180,000 in your portfolio in 20 years. Choosing an investment that charges 0.25% in fees gets you close to $210,000.
Which account balance would you rather be staring at in 20 years?
7 investing fees to keep an eye on
If you’re buying mutual funds or an exchange-traded fund (ETF), 12b-1 fees — aka expense ratios — are by far the biggest gotcha.
Expense ratios: The expense ratio represents the fund’s total annual operating expenses. It includes what the fund charges to cover the costs of marketing and distribution. (Yup, you’re paying for the financial firm to attract other investors.) The fee is taken directly out of the fund’s assets.
Expense ratios have been dropping over the years as individual investors have gotten wiser to the jig. Maybe you’ve heard that index mutual funds are the least expensive kind of fund to own. That is still true, according to the most recent fund data from the Investment Company Institute.
The average expense ratio for index funds is 0.07%. That means investors pay 7 cents in fees for every $100 invested. The average expense ratio for actively-managed funds (ones that employ a team of stock analysts to steer the ship) is 0.74%, or 74 cents for every $100 invested. However they can go as high as 2.5%. And in 2019 the average expense ratio for target-date mutual funds was 0.37% (37 cents for every $100 invested).
Other types of fees you might encounter if you’re a mutual fund investor include:
Sales loads: This fee is akin to a commission that either goes to the broker who distributes fund shares or is kept by the fund company. There are two main types of sales loads.
- A front-end load is deducted from an investor’s initial investment. There are rules about the size of front-end sales loads that generally dictate they can’t be more than 8.5%. (PS: Run screaming the other direction if you ever encounter a fund that charges anywhere near this amount.)
- A back-end load (also called a deferred sales load) is taken out of an investor’s proceeds when you sell your shares. The calculation for determining the amount of a deferred sales charge is more complex than the upfront load. However, a common setup is to gradually reduce the amount charged each year you keep your money invested. So you might pay 5% if you sell your shares within the first year, 4% after two years and so on until the load decreases to zero.
Redemption, purchase and exchange fees: These are fees that are paid to the mutual fund to cover the costs of doing business. The redemption fee is charged when you sell, the purchase fee when you buy and the exchange fee is charged if you transfer your money from one mutual fund to another within the same fund family.
There are other investment fees to keep an eye on. But these are less damaging over the long run since the amount tends to be fixed and not based on percentage of your assets. They are:
Account fees: If you’re a DIY investor you may encounter trading costs at the financial firm that houses your account. These include commissions (which, by the way, are much more expensive for mutual funds), account maintenance fees, paper statement fees, etc.
Administrative fees: These mostly show up in employer-sponsored retirement plans (like 401(k)s and 403(b)s). These fees pay for operating expenses (mailing out statements, etc.), maintaining the plan website, making sure all rules and regulations are followed. They are automatically taken out of your account and can run as high as 1% to 2% annually.
Calculate how much investment fees cost you
A simple way to see what fees you’re paying is to run the mutual funds you own or are considering is with the screener at the Financial industry Regulatory Authority (FINRA).
The FINRA Fund Analyzer has more than 30,000 mutual funds and ETFs in its database. It uses data from fund analyzer Morningstar, the National Securities Clearing Corporation to provide fund data and a rundown of fund fees (which you can also find in the fund’s prospectus).
The best part is how the analyzer calculates the costs to a shareholder over time. You choose the contribution amount, rate of return and holding period — and see exactly how fees and expenses impact the future value of your investment.
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