Here’s a quick, easy mental exercise: How close to the dollar can you recall your recurring expenses (mortgage, car, electricity, etc.). You’re probably on the money or close for most of them. But, how about for your investment fees? Is that a little harder?
Since investment fees are often deducted automatically from your accounts, it can be easy to overlook them. That helps explain why 22% of investors are “not sure” what investment fees they pay, while 23% think their investments and services are free, according to a Cerulli Associates report.
Fees and other related costs are just part of investing. You pay for the funds you invest in, and you pay for the help to manage them. But that doesn’t mean you should pay more than you have to.
Remember, the less you pay in investment fees, the more of your returns you get to keep.
Since your investments will make up a large portion of your retirement income, it is important to have a pulse on the fees you pay and how to keep them in check.
Know these types of investment fees
A big investment mistake is to invest in something you don’t quite understand, including the fees involved.
There are a wide variety of investment fees. While you will have to pay some to invest, others you can avoid. Here is a quick overview of some common investment fees.
Expense ratios/fund fees: Every mutual fund charges an expense ratio, which pays for the management of the fund. These annual fees are in the form of a percentage of your investment in the fund. They can range from less than 1% to more than 2%. Let’s say you invest in a fund that generates a 5% return but charges fees that total 2%. Then 40% of your return goes toward fees. Generally, high-fee funds tend to underperform cheaper funds because they have a larger expense to overcome.
Advisory or management fees: An investor typically pays a percentage of assets under management to a financial adviser. The average financial adviser fee is about 1%, but they're often charged on a sliding scale. So the more assets you have under management, the lower your fee percentage will be. However, some financial professionals are compensated by the products they sell.
Front-end and back-end commissions: These are also commonly called “loads.” These are sales fees that are charged when you buy shares (front-end) or when you sell shares (back-end). It’s important to be aware of the potential conflict of interest for advisers who make a living on commissions. Their incentive is to sell you products more so than to provide services that help grow your wealth.
12b-1 fees: These are fees charged by mutual funds to shareholders for marketing and distribution purposes.
Retirement plan fees: In addition to fund fees, employer-sponsored retirement accounts charge administrative fees to maintain the plan. Typically, it is you as the participant that pays these fees and not your employer. As the participant, you cannot control these costs, unless you and your coworkers can pressure your employer to change plans.
Avoid investment fees that don’t benefit you
As mentioned above, two types of investment fees are sales commissions and 12-b fees. These fees don’t directly benefit you. Rather, they generally benefit those who are selling or marketing the investment. For you, they essentially just lower your return.
Build a long-term portfolio
Any time you buy or sell an investment, you typically incur transaction costs. These can add up. Further, any time you sell an investment for a profit, you incur capital gains taxes, which are essentially indirect investment costs.
As an investor, the goal is to have investments the align with your long-term goals. That means making changes infrequently to your portfolio.
Make sure you’re getting a good return for adviser fees
The type of services provided vary from adviser to adviser. The adviser fee you pay should be worth the services you get in return. If you’re paying a 1% fee, it’s fair to expect comprehensive financial planning and asset management services. Some advisers offer additional services, such as tax-planning and preparation services. The point is that your financial needs are properly met relative to the fee you pay.
Why are investment fees so important?
Again, this is one of the most important investing lessons you can learn: The more you pay in fees, the less of your return you get to keep. That’s less money you have in your portfolio compounding and building wealth.
They may sound small and insignificant as a percentage, but they make a big difference over time.
A hypothetical investment of $25,000 earning an average 7% annual return with a 0.5% fee would grow to $227,000 in 35 years. That same investment with a 1.5% fee drops the ending balance to $163,000. Just a 1% difference results in $64,000 eaten away in fees.
Take a low-cost approach
As you see, there are major benefits to keeping your investment fees as low as possible. That goal can play a major part in your investment strategy.
Our philosophy is to consider cost in every recommendation to a client or move we make within a portfolio.
Knowing you are paying a fair share in investment fees is one step to increasing your chances at achieving retirement and other financial goals.
Controlling fees is just one of many steps to help you build wealth. For additional tips on preparing for retirement, download our free e-book: YOUR MONEY IN YOUR 50s: A RETIREMENT PLANNING GUIDE FOR PROCRASTINATORS AND AVID SAVERS.