It’s not what you make, it’s what you keep.
That bit of wry wisdom is incredibly important to all aspects of financial planning, including deciding which investments to purchase. While most investors understand the importance of considering tax implications when building a portfolio, too many people fail to understand the devastating impact that fees can have on our rate of return.
Many fees are easy to miss, often buried in the teensy print on purchase agreements and statements. Fortunately, they are also easy to avoid. As you build and tweak your portfolio, keep an eye out for what I call the Seven Layer Dip of Fees, and do your best to eat around them.
1. Mutual fund fees. There are plenty of good mutual funds that don’t charge large fees. Your investment advisor should offer you the option of “no-load” funds, which have no have an upfront or backend fees, or institutional share classes. No load funds have no barriers to entry or exit, and institutional share classes generally charge much lower annual fees.
2. Mutual fund surrender penalties. Some mutual funds charge huge penalties to pull out your money “early.” This is nothing more than an attempt to force you to stay in the fund. Penalty fee periods can be as long as eight years, or more, and run as high as 8% of the value of your investment! If you are offered such a fund, run for your financial life.
3. Internal mutual fund operating costs. Mutual Fund managers make their living off the fund’s Expense Ratio. The charges vary greatly from fund to fund. High process, “actively” managed funds, that seek to outperform the market (and rarely do), are in the 1 to 1.5% range.
Index funds, which attempt to “passively” track the return of the market require much fewer people and research to run, and actually outperform the majority of “active funds”. They also have much lower fees, in the .07% to 0.50% range.
4. Brokerage trading commissions. It’s ridiculous to pay a stockbroker hundreds of dollars to make a trade when can open an online brokerage account and make a trade for less than $15. Independent advisors can trade on behalf of their clients for as little as $8. If you want to do your own buying and selling, Charles Schwab, TD Ameritrade and Fidelity are great places to start.
5. Wrap management fees. Many large investment firms offer what they call “fee-based” accounts. This is supposedly an alternative that allows clients to avoid the high brokerage costs associated with the big outfits. But be wary – the management fee, generally a percentage of assets under management, goes to the broker and is often layered on top of the mutual fund fees and account fees charged by many of the big banks and brokerage firms. At the end of the day, you can still end up with an investment cost of more than 2% – on what is marketed as a fee-conscious investment account. Ugh.
6. Markups on bonds and new issue securities. Advisors at big banks and brokerage firms have the ability to sell you individual bonds and stocks from their firm’s inventory. The dirty little secret: advisors are allowed to “mark-up” the price of the bond or other security when they buy it for you and keep the difference. This can be a hard fee to quantify as the commission is often built into the price of the security. To add to the pain, brokers can also “mark-up” the price when they sell the security for you – a double whammy of fees!
7. 12b-1 fees. These are “marketing fees” that mutual fund companies give back to advisors and firms that sell their clients into the fund. Sounds a lot like a kickback, huh?
There is a lot of debate right now about how 12b-1 fees should be disclosed and whether or not they are appropriate. Keep your eyes open for them.
Of course, brokerage firms, big banks, mutual funds and investment firms can’t help you manage your money for free. They have to charge for their expertise, counsel and time.
However, it’s a documented fact that excessive fees are among the biggest killers of investment performance over time. Ask your advisor, or broker, exactly how they are getting paid, and all the ways that you are paying for their service.
The less dip you have to eat, the more chips you’ll have left over in retirement.
Check Out: 4 Helpful Tips For Investors Of Any Age