Fees are an unavoidable evil of investing, but that doesn’t mean you have to overpay when it comes to them. Few people pay much attention to their investment expenses when times are good, but what they don’t realize is those pesky little fees can eat away at their returns.
Take a $100,000 investment portfolio for example. If you pay 0.50% in fees annually for twenty years, those fees will reduce your portfolio value by $10,000. If the fees are 1%, that reduction climbs to close to $30,000 over the same period. For investors who want to optimize their portfolio and reduce investment fees, there are some easy ways to do it. But before you can start looking at ways to reduce the investment fees you pay, you have to first understand what they are.
Regulations require investment fees to be more prominently disclosed, yet it is still very confusing to investors who don’t have the time to sift through a long prospectus to figure it out. In fact, according a 2011 AARP survey of 401(K) plan participants found a whopping 71 percent did not even know they were paying fees at all.
One of the most well-known fees is the expense ratio or the amount that goes to administrative fees, management, advertising and other back office expenses. If the fund has an expense ratio of one percent that means 1% of your investable assets will go to cover the expenses of running the fund. The expense ratio is going to vary depending on your investment. Another big fee an investor can be hit with is the commission if the fund uses a brokerage firm to hawk their product.
Fees cannot be completely avoided, but they can be reduced. From going after low-cost funds to getting more passive, here’s a look at four ways to lower your overall costs of investing.
Get A Little Passive In Your Portfolio
For actively-managed accounts, whether it’s a mutual fund or brokerage account, investors are typically going to pay more in fees than passive investments or those that don’t have a person actively managing them. According to Morningstar, investors pay on average 1.2% in fees in actively managed funds, while the average electronic traded fund (ETF) charges 0.44%. An easy way to lower the amount you pay in fees is to move to a low-cost fund like an index fund that tracks a specific indices or an ETF. Even a bond fund can be cheaper than an actively managed one.
If you like the idea of having a portfolio manager running your investments, then find one that isn’t going to charge you a lot in fees. Safe bet: go with an actively-managed fund that keeps the expense ratio at 1% or less.
Go With A No-Load Fund
Not all mutual funds are created equally and so are the fees associated with them. Mutual fund companies aren’t non-profits, which means they want to make money. The question investors have to ask is just how much.
In order to keep the cost of a mutual fund down, investors should try to avoid any fund that has a load associated with them. That means the fund is paying a commission to whoever is selling their fund for them.
If the mutual fund has a front-end load that means you are charged the commission upfront. If it’s a back-end loaded fund, you get hit with when selling the mutual fund within specified number of years. The fee is highest in the first year and decreases annually until the holding period ends. That load or commission fee can be up to 5% of the invested assets and is something that is avoidable by choosing a no-load mutual fund, which has zero commission attached to it. A quick way to tell if the fund has a commission associated with it is if it is listed as Class A, B or C.
Choose A Discount Broker To Save On Fees
Investors who like to take charge of their portfolio by picking and choosing their stocks can easily get into expense fee trouble if they use a brokerage firm that charges a lot per trade. You may like the research, tools and other services associated with the trading firm, but if you are paying $19.95 per trade versus $4.95, it can eat away at your profits big time.
Don’t want to give up that pricey brokerage firm? Then another way to reduce your fees is to reign in the amount of trades you make. Transaction fees can add up, and keeping a lid on them can save you money. Not to mention, doing so will force you to be a buy-and-hold type of investor, which could reward you in the form of higher returns over the long haul.
Beware Of Those Little Fees
In this fast-paced world we live in, it is understandable that people don’t have time to pour over their investment accounts to identify fees they are paying, but taking the extra time can be financially rewarding. Take the annual fee as one example. Some brokerage firms will hit you with an annual fee if you don’t trade or if you don’t maintain a specific amount in your account. Knowing that rule ahead of time can help you avoid the fee or go with another firm that doesn’t have it or is willing to waive it.
The Bottom Line
Investment fees are an unavoidable part of investing, but they don’t have to be so big that they chip away at your returns. After all, nobody wants to see thousands of dollars in gains disappear because of fees. Choosing low-cost mutual funds, going with passive investments like an ETF or an index fund, and being aware of how much you are paying in fees can go a long way toward reducing the amount you pay to invest.