Have you ever seen a real estate closing statement? If you have then you know that buying a house—or even refinancing the one you already own—can involve dozens of fees, from very small ones to very large ones. Individually, none are a deal breaker. But collectively, they add up to several thousand dollars that can equal a few percentage points of the property value.
Though it’s not quite as extreme when it comes to investments, there are still plenty of fees that can be charged for the maintenance of your investments. Not all are charged on the same investment or in the same account, but they can still add up. How much you pay in investment fees can matter over the long run, and to no small degree.
What are typical investment fees?
On any given investment security, you may pay one or more of the following fees:
Account maintenance fees. This is typically an annual fee, and not very large at that—it’s usually less than $100 and it’s not charged on all accounts. Often, the fee will be waived if your portfolio is above a certain dollar amount, or if you make above a certain number of trades each year. Still, if you have an account with a small balance, the fee can make a difference. A $10,000 account with a $50 annual maintenance will reduce your investment return by one-half of one per cent.
Commissions. Sometimes this is a flat amount, like $4.95 or $7.99 per trade on stocks at discount brokerages, while at full service firms it can be a flat amount plus a percentage of the trade. Generally speaking, it will be higher on certain types of mutual fund or ETF trades, but it all depends on the broker you’re working with.
Mutual fund loads. These can take the form of front-end loads only, back-end loads only, or a combination of both. Many brokerage firms that have their own mutual funds will waive loads if the funds are held in brokerage accounts with the same broker.
12b-1 fees. This applies to mutual funds and it’s a fee that’s charged internally. Though it’s considered to be an operational fee, it’s mostly used for marketing and distribution fees. Though you won’t pay this fee out of pocket, it can reduce the value of your fund by as much as 1%, and it will be deducted every year that you’re in the fund.
Management or advisor fees. Some investors want nothing to do with managing their investments, and are willing to pay professionals to manage their accounts for them. There is of course a fee for this service and it can be substantial. Management fees can be a flat amount, a percentage of the value of the account or a combination of both. You’ll usually pay several thousand dollars for this fee ($5,000 on an $200,000 account is not unusual) and it will be charged each and every year.
In addition, a broker or other custodian can (and usually do) buy securities at a certain price then sell them to you at a slightly higher price. It’s not a huge mark-up by any means, but on top of some of the fees above it only raises the cost in investing. And it does it in a way that’s virtually invisible.
Why investment fees matter
Investment fees are part of the cost of investing. But how much you pay for those fees does make a difference, especially in the following situations:
Investment fees and declining markets. Many investors are willing to pay investment fees—as long as they’re making money on their investments. But when they’re losing money, the cost of investment fees magnifies the loss.
Let’s say that the stock market declines three years in a row: 10% the first year, 12% the second, and 8% in the third. You’re total loss will be something on the order of 30% of your portfolio. But if you average 3% per year in investment fees, you’ll have to add 9% to the 30% loss you took on your investments, for a three year total loss of 39%.
Always ask yourself if the price you’re paying for investment fees in a rising market will be equally acceptable to you in a declining one.
The cost of investment fees for the long-term investor. Let’s do this by example. We have two investors, each with a $100,000 investment portfolio, earning an average base rate of 10% per year in the stock market over a 30 year period. One investor averages 3% in investment fees for a net return of 7% per year, the other averages 2% in investment fees for a net return of 8%.
After 30 years, the first investor’s portfolio has grown to $761,225. But the second investor’s portfolio has grown to $1,006,265. That’s a difference of $245,040—just for paying 2% in annual investment fees versus 3%!
Yes, investment fees DO matter—a lot!
Chopping investment fees to the bone
OK, so we agree that investment fees matter; but what should you do to cut those fees down?
- Look for brokerage accounts with no annual maintenance fee, or at least one in which you can qualify for a waiver of the fee.
- Use a discount broker that charges the lowest transaction fees, especially if you are an active trader.
- If you invest in mutual funds, stay with the no-load funds, or look into ETF’s—the fees are generally lower.
- Pay attention to 12b-1 fees in a mutual fund prospectus. They can range from .25 to 1.00% of the fund’s value, and they’re assessed each year.
- Avoid using an investment manager unless you know absolutely nothing about investing. And even then, consider doing it yourself with index funds.
Most investors incur several investment fees, and while you won’t be able to eliminate or even reduce them all, each one that you can will make big a difference.