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How Investment Fees Can Ruin Your Portfolio Returns


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Investing is a good way to start building long-term wealth. You can put your money to work for you by purchasing stocks, bonds, mutual funds, and other securities.

However, many of these investments involve fees, and investment companies often charge for their services.

What seems like a small fee can have a huge effect on your total returns when compounded over many years. Understanding investment fees, when you pay them, and how they affect your portfolio is an important part of making the most of your money.

How Investment Fees Affect Portfolio Performance

In many cases, you can’t avoid investment fees, but that doesn’t mean you shouldn’t work to minimize them. Even a fee that seems innocuous can have a major impact on your portfolio.

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For example, mutual funds are a common investment choice for people who want diversified portfolios without having to buy dozens of individual stocks and bonds. These funds charge a percentage of your invested assets in the form of an expense ratio (more on that below).

Consider a mutual fund with a 0.5% expense ratio. You invest $1,000 per month, every month, for 30 years. The fund earns 9% per year. At the end of the 30 years, you have $1,502,134.95.

Now consider a fund that charges just 0.25% for its expense ratio. With the same investment strategy and the same 9% annual returns, your ending portfolio value is $1,573,685.35.

Although 0.25% doesn’t seem like much, it cost you more than $70,000 over the 30 years you kept your money invested.

A small flat fee can also have a significant impact on your portfolio’s ending value. A $60 annual account fee on top of a 0.5% expense ratio leaves you with $1,494,624.28 after 30 years. Even though you only paid $1,800 in fees, you also missed out on more than $5,700 in returns.

Types of Investment Fees

There are many kinds of investment fees you should watch out for. Some fees are obvious and easy to understand but other investments can have hidden fees or ones that are difficult to figure out.

Transaction Fees

A transaction fee, also called a commission, is a fee you pay whenever you make a transaction in your brokerage account.

For example, say your brokerage charges $5 every time you place a buy or sell order in your account. If you want to buy $1,000 worth of stock in company XYZ, you’ll have to pay $1,005 to complete the transaction.

If you sell those shares a few years later for $1,300, you’ll only get $1,295 because you’ll have to pay another $5 fee. Instead of making $300 in profit, you make $290 and the brokerage makes $10.

Transaction fees are becoming less common thanks to the rise of discount brokerages, which don’t charge any commissions to buy and sell stocks. Many larger brokerages, such as Vanguard and Fidelity, have cut their commissions in response.

Still, some companies continue charging these fees. And even firms that reduced their commissions for online transactions still charge if you want to place an order through another method, such as over the phone.

Management Fees

Investing is complicated, so many people work with professional advisors to help them construct and maintain their portfolios. These advisors charge for their services, often taking a percentage of the assets they manage on your behalf.

For example, an advisor may charge 0.25% of your invested assets per year. If you have $100,000 under their management, you’ll pay $250 for their services. As your portfolio grows, the fee increases. If your investments lose value, the fee goes down correspondingly.

This is also a popular fee structure for non-human investment advisors. Robo-advisors are programs that automatically manage your investments based on your investing goals and risk tolerance.

They offer features like automatic portfolio rebalancing and tax-loss harvesting. Most robo-advisory firms also charge a percentage of your invested assets each year.

Annual Fees

Some accounts charge annual account fees. Depending on the type of account, you may be able to avoid these fees by meeting a minimum account balance or signing up for electronic document delivery.

With other accounts, you can’t avoid the fees and simply have to pay them. You might see these fees listed in your account statement as an account fee, maintenance fee, or custodian fee.

Annual account fees are particularly common for retirement accounts like IRAs and 401(k)s. The fees typically range from $25 to $100 per year.

Account Closing Fees

Investment firms have a vested interest in keeping you as a customer. As long as your money is in their account, you have to keep paying their fees.

Many brokerage firms discourage people from closing their accounts by charging account closing fees or external transfer fees. You could pay as much as $100 to transfer your investments to another firm or close your account.

If you’re closing an account with one brokerage because you want to open a new account elsewhere, it’s worth asking your new brokerage if they’ll cover the fee for you.

Many companies are willing to pay some or all of your account closing fees if it lets them get you as a new customer. The worst that can happen is that the new brokerage company says no.

Mutual Fund Loads

Mutual fund loads are transaction fees that apply to mutual funds. Unlike commissions charged by a brokerage to hold your investments, mutual funds providers set their own load fees.

There are two main types of loads: front-end loads and back-end loads.

With a front-end load, you pay a fee when you purchase shares in the mutual fund. Typically, the fee is a percentage of the amount you invest, although larger investments might cost a smaller percentage.

For example, a mutual fund could charge a 5% load for investments up to $20,000, 4% for investments between $20,000.01 and $100,000, and a 3% load for investments over $100,000.

Back-end load mutual funds charge a fee when you sell your shares. Like front-end loads, the fund typically charges these fees as a percentage of the proceeds from the sale. With some back-end load funds, the fee decreases the longer you hold the shares.

For example, you may pay 5% for shares sold within two years of purchase, with the fee dropping by 1% for every two additional years you hold the shares.

Every mutual fund can set its own loads, investment minimums, and schedule for reducing those fees. Some funds have no load at all. Before you buy shares in a fund that has loads, you must understand how the fund calculates its fees and how they’ll impact your investment.

Mutual Fund Expense Ratios

Mutual funds charge an ongoing fee, called an expense ratio, based on the amount of money you invest.

The fee compensates the fund’s managers for handling all of the fund’s transactions and ensuring your investment stays diversified according to the fund’s investment strategy.

Expense ratios can vary widely. Simple index funds that don’t make many transactions can charge less than 0.1% per year. Actively managed funds can charge expense ratios over 1%.

You don’t pay expense ratio fees with additional money in your brokerage. Instead, the fund takes the fee directly from the money you have invested, adjusting the value of the fund’s shares to account for the charge.

That means you don’t have to worry about paying the fee with uninvested funds.

How to Reduce Your Investment Fees

Investment fees can have a significant impact on your portfolio’s performance, even if they seem small at first glance.

One of the best ways to earn more money from your investments is to pay fewer fees, so taking steps to reduce your costs is essential.

Choose the Right Brokerage

A key part of reducing your investment costs is choosing the right company to invest with.

Each brokerage sets its own fee structure, charging account maintenance fees and commissions as it sees fit. You want to find a brokerage that offers the account types that you need while having a reasonable fee structure.

Also, many brokerages have their own lineup of mutual funds you can invest in. Investing in your brokerage’s funds can earn you perks or help you save on costs.

For example, opening an account at Vanguard and investing in Vanguard funds can help you earn higher account status, which gives you access to financial advice and other assistance from Vanguard. If you used an account at Vanguard to invest in Fidelity funds, you’d miss out on those perks.

If you plan to open an IRA at a brokerage, pay close attention to whether it charges custodial or other fees for retirement accounts. A service like Blooom can help you analyze the fees your brokerage charges, as well as any investment fees, such as expense ratios, that you have to pay.

Invest in Index Funds

Generally, actively managed mutual funds charge much higher expense ratios than passive funds.

There’s little evidence that active funds can beat the market consistently, especially when you factor in fees, and paying a high expense ratio for an investment that underperforms the market is a bad deal.

Index funds, which aim to track a specific market index such as the S&P 500, tend to charge far lower fees, often 0.05% or less. You can match the performance of the market and keep fees incredibly low by choosing a passive fund, which could improve your portfolio’s overall return.

Work With a Fee-Only Advisor

Many financial advisors charge a percentage of your portfolio to help you invest, but they’re not the only option available. If you want to keep costs low but want a second pair of eyes to look over your investment plan, a fee-only advisor can be a nice middle ground.

If you need help finding a fiduciary advisor, SmartAsset has a tool where you can answer a few questions and they will provide you with some options in your area.

Fee-only advisors charge you on an hourly basis for investment and other financial advice. Put together a plan and set up an appointment for a few hours with a fee-only advisor. They can look over your plan and give you suggestions for how to tweak it, all for a few hundred dollars.

Seeing a fee-only advisor once every year or two can cost much less than investing with one who charges a percentage of your invested assets, especially if you have a lot of money in the market.

Final Word

Investment fees are one of the most controllable aspects of investing. Every fee you pay reduces the amount of money you have in the market, working for you.

Some fees are one-time payments, while others are ongoing. You could pay flat fees or fees based on how much money you have invested. Regardless of the kind of fee, every fee will worsen your portfolio’s performance.

Taking steps to reduce your investing costs, such as investing in index funds or selecting a low-cost brokerage, can help you make the most of the money you have available to invest.

TJ is a Boston-based writer who focuses on credit cards, credit, and bank accounts. When he's not writing about all things personal finance, he enjoys cooking, esports, soccer, hockey, and games of the video and board varieties.