- Why investment fees matter
Most investors will tell you that when a good investment comes around, you may have to act fast. It is easy to get caught up in details such as working out your assets and predicting the tides of the market. Small but essential features, like investment fees, can get overlooked. To complicate things further, you have to be on the lookout for fees in numerous forms. That's if you want to preserve your profits.
Think of it this way: You are depositing money in a retirement account so that you can reach a financial goal. You'll use about 5% of your savings each year in retirement if you want to ensure 20 years of income.
With that in mind, you'll notice a significant difference in your earnings if you pay more manage your investments. For some investors, that could mean a loss of $84,000 (or more) in investment fees over 35 years. As a result, you can miss out on valuable retirement income.
- Investment fees and my return
What you pay to manage your funds can significantly affect your annual rate of return. If your portfolio is showing gains of 8% for the year, but your expenses are at 2%, your return is actually 6%. Over the course of your career, that can add up to a lot of money.
In this example, let's use an investor that makes $100,000 and contributes $3,000 of his or her income to a deferred savings plan. The account has an annual rate of return at 8%. The investor increases his or her deposits by $1,500 each year until the plan maximum is reached. As the investment fee rises, more gets taken from the investor's profits. Just look at the numbers in the table below:
Fees Net return Account value after 35 years Total lost to fees 0.5% 7.75% $1,817,895 $189,671 1% 7% $1,648,091 $359,475 2% 6% $1,359,670 $647,896
By selecting investments with a fee of 0.5%, the investor can enjoy $458,225 more earnings than if he or she paid 2%. As you can see, the results are quite dramatic.
Also consider this: Investment fees come in many different forms. You’ll have to weigh each expense along with the combined total of your fees. In the next section, we’ll take an in-depth look at what expenses could be waging war on your investment earnings.
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- Common investment and brokerage fees
With the amount that you stand to gain, it's worth learning about the investment fees you might have to face. Costs will vary between brokerages based on the type of trades or services you want. Exact pricing can generally be found on each broker's website.
That said, you will likely experience annual account fees plus additional costs for your assets under an advisor. Then you'll have various per trade costs to watch out for, like expense ratios, transaction fees, and sales loads.
For more details, take a look at the standard expenses most investors have to face below. Each fee has its own dedicated section.
- Expense Ratios
Operating costs are a small percentage of your investment that gets charged yearly. These values can generally be found in the fund's summary, called a prospectus or white paper. Some funds, such as small-cap mutual funds, have higher expense ratios than bond funds, due to the nature of each security.
A number of factors determine whether an expense ratio is reasonable, like the volume of assets and how actively they are managed. It's entirely possible to build a portfolio on funds that have a 0.5% operating ratio per year (or less). At that rate, you'll only pay $5 on every $1,000 you invest.
However, the least expensive options are not always best. You should continually assess the overall expense ratio of your portfolio when making critical investment decisions.
- Advisory Fees
Advisory Fees. When an advisor helps to manage your investments, they generally charge a quarterly fee.
Many brokerages and advisors base their cost as a percentage of your assets. Management fees tend to be higher for smaller accounts (up to 2%) and more favorable towards portfolios over $1M (under 1%).
- Account Fees
Account fees/custodian fee. The custodian that is managing your account may charge a fee for some of the services they provide.
Yearly charges are typically up to $100 per year. For retirement accounts that just require regular IRS reporting, the costs could be slightly less.
Alternatively, some brokerages won't have accounts fees but can charge for any services you need. You can get billed for things like inactivity, wire transfers, printed statements and closing an account. As a result, account fees can vary quite a bit.
The best investment houses will often have minimal account fees though. While some charge for data, reputable brokers should offer research at no cost. Many of the high-end trading platforms are available for free too.
- Trade commissions and transaction fees
When a broker trades your stocks or ETFs, he or she will likely charge commission. For mutual funds, there can often be a transaction fee.
Commissions differ between brokerages and by the value of the investment. Stocks and ETFs can cost $5-$30 per trade, with assets over $1M dropping to $2 per trade. By contrast, mutual funds range from $10-$50 for every purchase, sale, or exchange of no-load funds (more on this next). Most brokers will also have a list of funds that they will trade commission-free.
- Sales Loads
Sales Load Mutual funds don’t always have transaction fees. Sometimes a fund can have a sales charge instead. The sales charge generally gets paid to the broker who sold the fund.
When the sales charge is a percentage collected up front, it’s called a front-end load. With a front-end load, the fees get subtracted from your initial investment. If you were to invest $5000 on a fund that has 4% front-end load, your actual investment becomes $4,800 (4% of 5,000 is $200).
By contrast, a fee can also be charged when shares of a fund are sold, called a back-end load. Typically, back-end loads are most expensive when shares are traded in the first year. The sales charge tends to get smaller the longer you hold on to the fund. Eventually, the sales charge can drop entirely. For that to happen, you'll likely have to hold on to the security for many years.
Unlike the expense ratio, sales loads can be wholly avoided. A mutual fund with no sales charge is called a no-load fund. Investing in no-load funds can be an efficient way to preserve your capital.Bottom Line
As an investor, you will always have to be on guard for fees. Though this page lists the most common investment expenses, it’s possible to experience fees not on this page. When you receive an account statement, your fees should be documented. Even if you think you are paying a reasonable amount, it can pay off to check out your options.
Even in the case of a 401k, most investments come at different costs. Many plan holders are shocked to find out how much they are paying, and how easy it is to opt for lower fees. And by choosing friendlier fees, you can have a much more comfortable retirement.