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Investors: Don't Let Fees Reduce Your Returns

With rare exception, most investors are paying far too much for their investments. Whether they invest through mutual funds, an advisor or on their own, their costs are usually far more than they should be paying. Why? Because mutual funds and broker/dealers really don't want customers to know it. Yet, even what look like small changes will amount to a big deal over time.

As an example, let's use a $250,000 investment over 10 years with annual costs totaling 2%. If that investment grew at a rate of 6% after those expenses, it would total $447,712. If the expense rate were reduced to 1%, the total would climb to $491,788. So a seemingly small expense reduction of only one percentage point would add a whopping $44,076 to an investor's nest egg. (For related reading, see: Choose ETFs Over Mutual Funds for Your Portfolio.)

Where the Costs Come From

What's the problem? Among the top offenders are mutual funds with front-end loads, known in plain English as sales charges. Front-end loads, typically found in Class A shares, can run as high as 5.75%. So when you make an initial investment of $10,000 in one of those funds, the value of the shares you bought would be down to $9,425 on day one. That makes no sense, which is why load funds continue to lose assets and now account for only 20% of all fund assets. No-load funds (those with no sales charges) dominate the industry.

Front-end loads aren't the only way they get you. Sometimes, the broker will tell you that there's no sales charge. What you won't hear (but should) is that there will be a charge when you redeem—or perhaps an annual fee. The former is a Class B share; the latter is a Class C share. Either way, you would be paying too much. 

Another wrinkle in the Fees You May Not Be Aware Of category is the 12b-1 fee, which is an annual marketing fee charged by the fund. Those 12b-1 fees, which have been the subject of ongoing discussions, typically range between 0.25% and 1.00% per year. When wrap fees were introduced some years back, the annual cost to the investor was an egregious 3% per year. A wrap fee was an all-inclusive deal that included both advisory services and transaction fees. As time passed, wrap fees came down, but there are still more than a few at 1.75% to 2.0% per year. (For related reading, see: Understanding the Fees Charged by Financial Advisors.)

Let's not forget commissions for stock trades. In the golden days of stock brokerage, commissions were set at fixed rates and individual trades often cost well in excess of $100. On May 1, 1975, however, fixed commissions were abolished. These days, a typical trade will cost about $7-10. If you're paying much more, you're being robbed.

Adviser fees also vary widely. Advice and management services will generally be higher for equity investments and lower for fixed-income investments. Although there are advisors whose fees are as high as 2% per year, most tend to fall in the range of 1%-1.25%. If you're paying more, tell your advisor it's too much or move your assets to an advisor with reasonable fees.

In these times of relatively lean returns among most asset classes, investors are best advised to be extremely careful not to overpay. The lower your fees, the higher your returns. That's the point, isn't it? (For related reading, see: 3 Unconventional Reasons to Hire an Advisor.)