Say you’re looking to get into investing and you’re not sure where to start. You’ve already checked into our Investing for Dummies and even Investing in Stocks for Beginners articles for some insight. But have you looked at all into the types of investment fees that actually investing can incur?
Just like the convenience fees you encounter when booking a flight, there are costs associated with investing too! Putting money into stocks and funds often has investment fees that you should know about. If you’re not paying attention, these investment fees could greatly reduce the money you put into savings like your 401(k). In fact, one study showed that 1% extra in fees may cost millennials upwards of $600,000 in returns across a 40-year timespan!
However, some of these fees are actually put to good use! Some are to help ensure good management of your investments, while others may buy some financial expertise. We recommend understanding the different types of investment fees to help you get good financial returns without excessive deductions. Plus, it’s just good practice to know all of the “in’s and out’s” before investing in anything.
With that being said, let’s crack open the mystery behind investment fees!
Before we continue, Financial Professional wants to remind you that this article is educational in nature. Any securities or firms named are for illustrative purposes only and do not constitute financial advice. Always do your due diligence and consider your situation – and the help of a licensed financial professional – when making investment decisions.
If you don’t yet have industry professionals handling your portfolio, we can help! Check out Financial Professional’s investment marketplace, where we partner with some of the best in the business to help find the right investment for you.
Depending on what investment you are looking into, there will be different types of fees. These costs may seem to be deceptively low, but when you calculate how much you’ll actually pay, the numbers may shock you! 0.5% versus 2% in fees makes a HUGE difference in your financial return on investment.
Let’s say that you invest $100,000 into an account that earns 8% yearly with 0.5% yearly fees for 25 years.
By using the return estimation of 100,000 X 1.07525, you will have about $610,000 by the end of 25 years. However, this doesn’t take into account any annual fees.
Now, let’s say that you invest the same $100,000 at 8% interest for 25 years. This time, however, you pay 2% annually in various investment fees.
100000 X 1.0625 will return a total sum of about $430,000 – a total difference of about $180,000 less!
This just goes to show how much of a difference that 1.5% in investment fees can make. While it may not seem like much money compared to your total return, $180,000 may be the difference between retiring at 70 versus 73. (If you want to run your own calculations, check the federal website for a more precise fund calculator.)
These examples demonstrate a common investment charge called an expense ratio. This fee is often found in investments such as mutual funds. In essence, an expense ratio is a measure of the costs you pay to manage the fund based on the total assets you invest. Instead of charging you directly for the management cost, the payment comes out of your returns as expense ratios.
That’s why, even if your return is 8% annually, a 2% fee can cut your actual return down to 6%. And remember: each dollar taken out for management costs is one less dollar to invest in your portfolio.
This is why it’s important to analyze your potential investment fees: to potentially prevent large monetary losses. To that end, let’s explore some of the more common types of investment fees you may encounter in your investment journey.
To a beginner investor, the term “loads” may sound odd – especially if you’re hoping to not pay “loads” of fees! So let’s define it!
When you buy shares in a mutual fund, there are two additional parties other than yourself. The first is the investment professional from whom you’re buying the shares; the second is the company issuing the shares. Because the professional acts as a middle party, he/she receives a percentage of the money you invest.
This sales charge, known as a “load” fee, is incredibly crucial in the investment world. We can sub-categorize loads into three categories:
These fees are one-time occurrences that funds charge up-front. Typically, front-end loads range from 3.75% to 5.75% of the investment cost, though they can vary in amount.
Most commonly, the fee is removed directly from the capital you invest in the fund. For instance, if you hand over $20 to a mutual fund with a front-end load of 5%, the next day your shares will be worth only $19 due to the 5% fee.
Take front-end loads and imagine the complete opposite, and there you have a back-end load! Instead of charging a fee when you open an account, funds charge back-end loads when you take money out.
This fee usually decreases each year that you own the fund – but like all good things in life, there’s a catch. These funds often have higher fees, commonly known as contingent deferred sales charges (CDSC).
Investments such as variable annuities and index annuities charge such fees because they often pay large up-front commissions to the seller. Therefore, to protect the company’s money flow, they require large back-end loads on the off-chance you decide to withdraw funds earlier than expected.
With each passing year, however, the company is able to financially recover from its initial costs, thereby decreasing your back-end fees. Some fund companies may even completely waive that fee if you hold an investment long enough!
Surprise! You don’t have to pay anything! Instead of going through a secondary party, your shares are distributed directly by the investment company – thereby eliminating any loads. However, there are still other fees like the 12b-1 fee that may total about 1% of the total balance.
And, if you’re an investment beginner, it may be wiser to use a “middle man” to handle your investments at first. Paying an expert or firm automatically increases your costs (while potentially mitigating some risk through expert financial knowledge).
No-load funds often have virtually no performance benefits compared to load-bearing funds, though they frequently have lower expense ratios.
If you have a financial advisor, you likely will have to pay a fee for managing your assets for you. These payments will either be through a load (commission-only), fee-only, or a combination of both, known as a fee-based plan.
Most advisors charge by how much of your money they manage, commonly known as “assets under management” (AUM) costs. Depending on the advisor, they may charge flat fees between $2000 – $7,500 or a percentage of your account, usually between 0.25% – 1% annually.
For a quick example: if you have a balance of $200,000 in your Roth IRA and you hire an advisor that charges 1% annually, you’ll pay $2,000 in fees.
As a rule, smaller accounts tend to have higher fees. However, if you have a larger portfolio ($1,000,000 or more) and are paying more than 1% annually in fees, you should be receiving additional services such as tax planning, budgeting assistance, and others. These additional services usually compensate for paying higher prices.
For those of you who aren’t sure which type of financial advisor to hire, it’s important to note that the decision rests on personal preference and your investment needs. For more information on how your needs affect your decision, check out our article on the role of a financial advisor.
These types of fees are charged by the broker handling your investment account and giving you personalized investment advice. It accounts for the annual fees to maintain and grow the account, access to trading platforms, and research on investing data.
Unlike financial planners, brokers will try to sell you their products and even charge fees for meetings. Some online brokers, however, will offer commission-free online trading.
Most brokerage accounts charge you whenever you buy or sell stocks. This may be a flat fee, a fee per share structure, or even a broker-assisted fee.
For flat fees, the broker will charge a single rate despite how many shares you purchase. Brokers usually charge flat fees, while most day trading brokers use the fee per share commission structure.
Under special circumstances, brokers can even place trades on behalf of their clients and then charge a fee for their service, known as a broker-assisted trade fee.
Not all online brokers will offer mutual fund trading. If you do find one who does, your options often depend on the type of fund you are trading. No Transaction Fee (NTF) mutual funds do not charge a fee upfront but may charge a fee if you withdraw the funds too soon. Usually, you have to hold your shares between 60 to 90 days to avoid such fees, but be sure to check with your broker first.
Similar to stock trading fees, brokers will often charge fees for trading options. To those who are unaware, options are contracts that give the buyer the right to buy (call) or sell (put) an asset at a specific price on or before a certain date. They can add value to a portfolio and even generate additional recurring income.
Online brokers will often charge a base fee per trade as well as a per-contract fee. On the other hand, many active trading brokers may only charge a per-contract fee.
Online brokers will also tend to charge exercise fees and assignment fees depending on the situation. So, if a client wants to exercise an option instead of closing it, the broker will charge the client. If the stock from the option is automatically bought or sold, the broker will charge a fee then, as well.
As the name implies, these types of fees are charged for the general management of an investment account. The brokerage firm may charge this fee monthly or annually, and the amount can vary based on if you choose additional financial services.
If you think those were all the costs to invest, think again! These next fees are based on the two major investment strategies: active vs passive. Each strategy carries different costs due to the way accounts under these strategies are managed.
For instance, in 2018, the average fee for active management cost 0.76% of a portfolio’s worth, versus the average passive management fee of 0.15%.
Passive investment managers carefully purchase mutual funds and exchange-traded funds (ETFs) that mirror a particular market index and hold them long-term. They do not pay much attention to the daily market fluctuations under the belief that the longer you hold your shares, the better your financial return will be. Typically, fund managers only change the investments under management if the benchmark fund changes.
This practice is known as the Efficient Market Hypothesis (EMH). In fact, in multiple studies, it has been proven to outperform most actively managed funds. Furthermore, since investment managers don’t do much active trading in a passively managed fund, they often don’t charge as high of a fee.
In contrast with passive management, active management actively tracks an investment portfolio and regularly buys and sells assets. Investment managers have to constantly stay on top of the latest investment research and data, while also using their personal knowledge to make investment decisions.
Despite the market’s frequent fluctuations, the reason they constantly change investments and strategies is that they aim to outperform the market as a whole. Due to their active involvement and understanding of financial risks, these managers charge much higher fees than passive managers.
If all these different investment fees intimidate you, don’t worry! Investment managers often charge these fees to help you manage your portfolio better (although rest assured, they’re also looking to make a profit, too).
With that being said, be sure to keep in mind these three things when comparing funds with various fees:
When considering all the types of investment fees, it’s important to note that the more you move your money, the more you’ll pay in fees. As seen above, buying and selling stocks will almost always incur charges as shares change hands.
There are also tax implications to consider with each of these investments, and even when selecting a financial advisor. We at Financial Professional strongly suggest looking into the nuances behind investment taxes and discussing them with your financial advisor.
The bottom line is that by increasing your financial IQ by learning about various types of investment fees, the better prepared you’ll be when it comes to investing. After all, the best investment is one when you know the full costs and make the choice best suited to your needs.