Investment Fees: What You Need To Know

How much are you currently paying in your investment accounts? I want to shed a little light on the various fees that you may or may not be paying currently, and suggest a few ways to eliminate or minimize what you can. Investment fees come in many different shapes and sizes, which makes it really difficult to figure out exactly what you are paying.

Much like the importance of keeping a monthly spending plan, I believe it is more important to know what you are paying in investment fees! As you will see below, reducing the fees being drawn out of your investment account will having a lasting effect on the sum of money you accumulate over your lifetime.

How Investment Fees Affect Returns

Before we get into the specific types of fees, I’d like to show you why this is important to understand. Investment fees have a direct relationship with the total return of your portfolio. For example, if your investment portfolio returns an annual rate of 8% but you have 1.5% in annual fees, your actual (net) return is 6.5%.

As you can see in the chart below, these fees can really add up when you look over a long period of time.

Here is an example of someone saving $200 at the beginning of every month over a 40 year period ($96,000 total investment). The average annual rate of return assumed is 8%, while fees shown range from 0% to 2%. Just like you need to keep an eye on your household expenses, you must also diligently watch the fees you pay inside your investment account.

Account Value vs. $ Amount Lost to Fees After 40 Years

Total fees lost when investing $200/month for 40 years at 8% gross rate of return, compounded monthly

Investment Management Fees

If you outsource the management of your investment accounts to an advisor, you are paying them a fee to do so. The industry standard fee advisors charge today is 1% of the assets managed (this fee may scale down for larger account values). If you have $100,000 invested, then you are paying $1,000 per year for this service.

How can you reduce this fee for professional management? Online brokerages continue to enhance their service offerings, one of which is a robo-advisor. These “robo-advisors” allow you to answer a set of questions to determine your risk tolerance and the algorithm will handle the account management from there. Typically, a robo-advisor will utilize low-cost index fund ETFs to invest your money. The fee charged by a robo-advisor is usually much lower than a human advisor - around .25-.50% of assets managed.

-Where to look: If you work with a financial advisor, their fees should be clearly listed in the contract you signed with them. You may also find the management fees taken out of your investment account on your quarterly statement. For robo-advisors, their fees will be clearly stated on their website, in the contract, and on your account statement.

Expense Ratio or Internal Fees

Expense ratios and internal fees are included in all mutual funds and ETFs. These fees are expressed as an annual percentage of your investment and are easy to find.

Be careful, expense ratios will not be listed on your account statements. The expense ratios are not deducted from your account, as the return you receive is net of the fees paid.

For example, a mutual fund with a .80% expense ratio means that you will pay $8 for every $1,000 invested in the fund. These fees are included to cover operating costs (investment team, research, etc.) and administrative costs (legal, reporting, etc.) of the fund.

There are two very broad types of funds to look for when trying to lower your costs. Active funds which are “actively” traded and managed to try and beat the market or Passive (or Index) funds that simply mirror a specific market index to match its returns. The cost difference between active and passive funds is dramatic. Typically, an active fund expense ratio will be 1-2% or more, while an index fund can range from .03-.25%. As you recall from the chart above, this will have a lasting impact on the total dollar return of your portfolio over time!

-Where to look: You can find fund expense ratios listed in the fund’s prospectus online, on your online brokerage’s website, or through an independent research site like Morningstar.com.

Transaction Fees

Any time a trade is placed to purchase or sell a stock, mutual fund, or ETF, there may be a transaction fee attached. The fee will range greatly depending on what is being traded (mutual funds usually being the most expensive). Also, the fee will range depending on the brokerage company you use.

For equity trades, like stocks and ETFs, the fee will usually range from $7-10. For mutual funds, the trade can range greatly from $10-75, depending on the brokerage company used and the mutual fund being traded.

To minimize these fees, the first step is to reduce the amount of trades you place! This is a key component of passive investing for the long-term. For my client accounts, we will rebalance their accounts once or twice per year, depending on market fluctuations.

The next step to minimizing transaction fees is to look at the fees you are being charged by your brokerage. Many brokerages offer no-fee transactions for a certain list of funds on their platform. However, this fee may be passed on to you in the form of a higher expense ratio, so always do your homework before investing.

-Where to look: On the brokerage’s website, you will find a list of their transaction fees, or on your account statement.

Sales Loads

Sales loads are commissions paid by an investor to their broker or financial advisor when purchasing a mutual fund to invest in. These come in 3 main forms - front-end, back-end, and level. The fee is in place primarily to compensate the broker or advisor for helping with a client’s investment needs. However, these fees can carry a hefty price tag and can be avoided very easily.

Front-end load funds carry a fee that is paid when you initially purchase the mutual fund (on the front-end). These fees vary by different investment companies, but are typically around 3-6% (or $30-60 per $1,000 invested). However, the fees will be waived if purchased inside a 401(k) or other employer-sponsored retirement plan. If a front-end load fund is purchased, it is suggested you do not sell the fund within 4 or 5 years of purchase, to avoid paying the upfront commission over and over again.

Back-end load funds carry a fee that is paid (you guessed it!) when investors sell the mutual fund recently purchased. This fee is a gradually declining fee put in place to keep investors in the fund they invested in. Generally, the back-end load will start out at 5-7% and decline over a 5 to 10 year period. For example, if you purchase a back-end load fund with a 5% charge and 5 year surrender period, the fee may look like 5% if sold in year one, 4% if sold in year two, and so forth.

Level load funds do not carry a front-end or back-end sales load, but do have an ongoing fee added into the fund’s operating expenses. This fee is most commonly known as a 12b-1 fee. Generally, this fee is about .25% per year (or $2.50 per $1,000 invested). At first glance, this may seem like a better deal than the previous variations mentioned, but remember that these loads can be avoided all together. Every .25% fee adds up inside your investment account, which will continue to erode your savings for years to come.

Lastly, you can easily avoid any type of sales load by investing in no-load funds. These funds will be lower cost to you, which will help reduce any unnecessary erosion inside your investment accounts.

-Where to look: If you work with a financial advisor, ask if the funds you are invested in charge sales loads or commissions. Fee-only advisors (like me!) do not invest in these types of funds. Inside your fund’s prospectus, on your broker’s website, or independent research sites, near the expense ratio and fee table.

Annual Account Fee or Custodian Fee

Annual account fees may be charged by your online broker for having your account with them. There are a few different charges that can add up, depending on your account size.

Annual fees are charged if your account value is below a certain level - typically $25,000 or $50,000. If you are below your online brokerage’s exemption level, the typical fee will range from $25-$75 per year, per account. If your account value is above your brokerage’s level, this fee will be waived.

Additional service fees may also be charged by your online broker. These may come in the form of paper statement fees, investment research fees, or inactivity fees. In total, these fees may accumulate to $10-100 per year, depending on the services you receive. To avoid these fees, be sure you are only paying for what you need, or find an online brokerage that does not charge for these specific services.

Finally, you may be charged an account closing fee if you close your account by cashing out your holdings or transferring to a new brokerage platform. The fee usually ranges from $50-75, depending on your brokerage. To minimize this fee, be sure you are happy with the online platform you are choosing before opening the account.

-Where to look: Online brokerages will clearly state their various fees on their website under “account fees”.

Watch Your Fees

As I mentioned from the start, it is crucial to understand how much you are paying in your investment accounts, whether you manage the accounts yourself or have an investment advisor. Either way, you want to understand your fees so you can make sure you are getting enough value out of what you are paying for.

Don’t get me wrong, investment advice can be extremely valuable for those that don’t want to take the time to manage and monitor accounts themselves. However, I believe you should always know how much you are paying, whether that’s the food you purchase at the grocery store or fees paid inside your investment accounts.

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