Fees are a required part of investing but is there anything you can do to reduce them?
Many investors don’t realize how much they are paying in fees. These fees can zap your portfolio’s returns.
Knowing about the various types of fees can help you reduce or even eliminate them.
In this article, we’ll go over the different types of fees that can destroy your portfolio returns.
Impact Of Fees
To get an idea of how fees impact investments, let’s first look at a few examples before we get into the details of specific fees.
Using the calculator on buyupside.com, a $10,000 investment with a 1.5% fee, 6% return that is held for ten years produces a value of $15,396.46. With only a 0.5% fee, the value is $17,032.93. That’s a $1,646.37 difference.
Let’s use a retirement account with the same parameters except for a starting value of $500,000 and held for 40 years. The value will then be $769,823.14 after 40 years. With a 0.5% fee, the value will be $851,646.69. A difference of $81,823.55.
The last example clearly shows the large impact that just a 1% fee difference can have on an account. This is why getting the lowest fees possible is important to your portfolio’s returns.
Mutual Fund And Index Fund Fees
Mutual funds come in two flavors - active and passively managed. Actively managed funds have a fund manager manually trading the account and producing fund performance. Because a fund manager is involved, fees will be higher than passively managed funds.
Fees for funds aren’t a separate transactions. They are taken when the position is opened or closed.
A passively managed account lacks a fund manager and thus has lower fees. The fund tries to mimic the performance of an index such as the S&P 500. These funds are also called index funds.
To get an idea of mutual fund and index fund fees, in a June 24, 2015 study, Morgan Stanley found that the average dollar-weighted expense ratios of actively managed were:
The same categories of index funds charged fees of:
The moral of the story is that if you can invest in passively managed index funds, you’ll pay much lower fees.
Some retirement accounts and mutual fund accounts come with an advisor fee. This fee is charged on the account value and usually in the amount of 1%. It’s in addition to any fees the fund may charge.
On a $100,000 account, 1% is $1,000 per year. The fee is usually taken directly out of the account instead of billed separately. 1% is a common advisory fee.
However, if you aren’t using a financial advisor, the fee is simply a waste of money and drag on your portfolio’s returns.
Some retirement accounts will include advisor services, whether you use them or not. Be sure you aren’t paying an additional fee for this service if you aren’t using it.
Robo advisors such as Personal Capital and Betterment have management fees of about 0.25% to .89% depending on your account value.
Betterment actually charges 0.40% for its advisory service.
A wire transfer can cost $25 or more per transaction. ACH is often available at no cost. A little planning can avoid wire transfer fees.
Some brokerages may impose a limit on ACH transfers each month. Check if such a limit exists and try to not go over it.
Mutual funds don’t charge a separate commission since it is built-in. Be sure to confirm this with your broker.
Trading stocks, bonds, and options will almost definitely require commissions. Self-executed online trading incurs the lowest commissions. While phone assisted trades will have the highest.
When trades are charged a commission, frequent trading will incur a large number of commissions and certainly eat away at returns.
Keeping trading frequency to a minimum under this fee structure will lessen the impact on returns.
Low Cash Interest Rates
Brokerage accounts aren’t known for their high interest on cash balances. The reason is that brokerages make money on the spread - the difference between the rate the broker gets on cash interest and the rate they pay you on cash interest.
This is why cash interest is usually less than 0.20%.
While this low cash interest isn’t a direct trading or investment related cost, it can still have a negative impact on your returns.
If you find yourself having a high cash balance in your brokerage or retirement account, consider moving the funds into a high return account or putting the money to work in a fund.
Besides fees assessed on funds, there are many fees brokers and financial institutions can charge that will negatively impact your portfolio’s investment returns.
Knowing about all the different types of fees a firm can charge will help you consistently generate positive returns with minimal fee impact to your portfolio.
Do you think your investment fees could be lower?
Robert Farrington is America’s Millennial Money Expert® and America’s Student Loan Debt Expert™, and the founder of The College Investor, a personal finance site dedicated to helping millennials escape student loan debt to start investing and building wealth for the future. You can learn more about him on the About Page, or on his personal site RobertFarrington.com.
He regularly writes about investing, student loan debt, and general personal finance topics geared towards anyone wanting to earn more, get out of debt, and start building wealth for the future.
He has been quoted in major publications including the New York Times, Washington Post, Fox, ABC, NBC, and more. He is also a regular contributor to Forbes.