Investing can be complex. Building a tax-efficient, diversified portfolio (or several) suited to your risk tolerance and capacity, time horizon, and goals is no small feat.
But the process doesn’t simply end with the portfolio’s construction—several elements swirl in the background that often go unnoticed unless you know what to look for: fees.
Investment fees come in all shapes, sizes, and percentages, all of which can have a significant impact on your net returns. These fees also live in every investment account you have like your 401k, IRA, and a brokerage account. Understanding these fees will give you more control over your investments and help provide greater context to how the process works.
Here’s what you need to know about investment fees, so you can walk into investing with both eyes wide open.
Investment fee basics
Investment fees are akin to buying tickets online. Have you ever browsed the web and found an amazing deal for your dream seats, only to be hit with fees at every turn? Processing, taxes, surcharges, platform fees, etc—as you quickly discovered, a ticket is rarely bought at the base price.
Investment fees are similar—they often fly under the radar, eating away at your returns each year. But investment fees aren’t all bad. The right fee keeps the fund operating properly and ensures that it’s managed well.
While there’s nothing wrong with paying for excellent service, in the world of investing, expensive isn’t always better. In fact, low-cost investing has proven time and time again to be more reliable than pricy mutual funds.
So what are the fees to watch out for, and how will you know if it’s reasonable or not? Let’s dive in.
A fund’s expense ratio covers the cost to run the fund: to keep the lights on so-to-speak. These fees are often charged as a percentage of your account balance. If a fund has a 1% expense ratio, for example, $10 of every $1,000 invested will go toward the operating expenses.
When looking at the fund’s prospectus (don’t skip this document), you’ll see that the expense ratio covers several types of fees like management fees, 12b-1 (marketing/advertising fees), and administrative costs.
Every fund is different in this respect, which is why you will see a vast array of fees as low as 0.2% to as high as 2.5%. Actively managed funds tend to be more expensive than passively managed funds, so keep this in mind when selecting your investments. At Step by Step, we believe in passive management and low-cost investing to help our clients reach their goals.
Loads and commissions
Many mutual funds build-in commission expenses called loads. These loads vary in cost and application—some are tacked on when you buy the fund and others when you sell it.
- Front-end load
- A fee is charged when you purchase the fund. Say you buy a class A share mutual fund with a 3% front-end load and a $12 share price. The next day, your shares are only worth $11.64 since .36 cents was charged upfront.
- Back-end load/Surrender charge
- This is the opposite construction from a front-end load. Instead of having the fee applied at purchase, it’s added to the sale. This fee usually decreases the longer you hold the fund. If you have a 5% back-end load in year one you might only have a 4% in year two, 3% in year three, etc.
- You read that right! Some funds don’t carry loads, but if this is the case, be sure to watch out for higher costs elsewhere like maintenance or administration fees—especially 12b-1 fees if you sell in the first year.
Want to buy or sell your shares? Some funds charge trading or transaction fees that accompany such a move. While these fees are on the decline, it’s important to know if you’re investing in a fund that charges them.
Depending on the fund, you could pay anywhere from $3 a trade to over $50! This enormous gap continues to highlight the many differences between funds.
Avoid trading fees by looking for the following:
- Custodians that offer commission-free trading
- Commission-free ETFs
- Other low-cost investment vehicles
Annual account fee
Most brokerage accounts and mutual funds charge an annual account fee, usually anywhere from $30-$100.
Management and advisor fees
If you’re working with a pro, you are going to pay them for their expertise. Fee structures vary widely for investment managers and advisors, but many charge an asset under management fee (AUM). AUM is often calculated as a percentage of your investments, the most common being 1%.
The most important thing is that your advisor’s fees are upfront and transparent. As a fiduciary, our clients always know what they’re paying and the value they receive for their investment.
Can you minimize investment fees?
Investing doesn’t have to be a high-cost endeavor, there are several ways to streamline the cost of your investments. Let’s take a look at a few ideas.
Take a long-term approach to investing
Investing isn’t a get-rich-quick scheme, instead, it’s a thoughtful and deliberate choice to help you grow your wealth over time. We believe in helping you construct and manage a portfolio that supports your long-term vision for retirement and beyond.
At Step by Step, that means employing low-cost investment vehicles like ETFs, mutual funds, and bonds in an intentional way.
Adopt a passive investment strategy
Passive investments seek to mirror securities in an index like the Dow or S&P 500. It often results in lower costs due to minimal trading/transaction and management costs. Active investing, on the other hand, seeks to time the market, chasing the biggest returns. This strategy often yields high broker and trading fees, which significantly impact your net returns.
Make your investments tax-efficient
Our firm is passionate about building a proactive tax planning strategy in all areas of your financial life, especially your investments. Taxes play a vital role in your wealth over time, making it important to structure your investments in a tax-friendly way.
We do this in a myriad of ways, namely with asset location—a strategy that seeks to place securities (mutual funds, ETFs, bonds, etc.) in the most tax-efficient account (tax-deferred, tax-exempt, taxable, etc.).
The bottom line on your investment fees
Investing will always carry fees, but you can be strategic about the fees you pay. Before investing in any fund, be sure to do your homework.
Our advice? Take a look at the prospectus. This document spells out the fund’s fees, which will give you a better idea of how much the fund will really cost you—instead of the pretty sticker price advertised on the website.
You might also find more confidence working with a professional who can guide you to low-cost options that best suit your needs. Are you paying too much in fees? Set up a call today, and we can talk through your plan together.