One of the most underrated factors with investment success is investment fee minimization. Investors often fail to see the long-term value of lower investment fees. But a seemingly insignificant difference of just 0.50% per year can have a major impact on investment performance over several decades.
For example, let’s say you invest $100,000 in a balanced portfolio of stocks and bonds with an average annual return of 7% for 30 years. In the process, your investment fees will average 1% per year, which will reduce your net return on investment to 6% per year.
At the end of 30 years, your portfolio will grow to $574,350.
But let’s say you use various strategies to cut your investment fees in half, down to just 0.50%. That will give you a net annual return on your investment of 6.5%.
After 30 years, your portfolio will grow to $661,438.
By cutting your investment fees in half, your portfolio will be larger after 30 years by more than $87,000!
It’s one of the very best ways to improve your portfolio performance without doing anything dramatic.
What are the highest investment fees you need to avoid and how can you eliminate or at least minimize them? Let’s do a deep dive into investment fees, keeping the above calculations in mind as you look at what might appear to be small differences.
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Table of Contents:
1. Commissions/Trading Fees
These fees are much less of an issue than they once were. Until 2019, there were only two or three brokers offering commission-free trades. But by the end of the year, the trend caught on, and there are now many brokers of all types offering free trades.
Working with such a broker is especially important if you’re a frequent trader. For example, let’s say you have a portfolio of $50,000, and you make 100 trades per year. If your broker is charging you $4.95 per trade, you’re paying nearly $500 per year in commissions. Since that represents 1% of your portfolio size, it will also reduce your investment returns by the same percentage.
You should be aware that even among commission-free brokers, free trading typically extends only to individual stocks, exchange-traded funds and options. Other investments, particularly mutual funds, still involve commissions. Those can be anywhere from $9.95 per trade to $29.99 per trade.
Alternative Strategy: To trade stocks, options or exchange-traded funds, open an account with an investment broker that offers no-fee trading on those securities. Examples include Ally Invest, E*TRADE, and TD Ameritrade. Each provides all the tools and resources you’ll need for successful self-directed investing, but none of the fees still charged by some brokers.
But be aware that even though a broker may offer commission-free trading, that will only apply to online trades you execute without broker assistance. If a trade requires broker assistance there will be a fee, that can be as high as $30 per trade.
2. Load Fees
These are sales charges that apply to the purchase and sale of mutual funds. Collectively, load fees can be as high as 8.5% of a fund’s value. But more typically, they range between 1% and 3%.
Load fee structures are different between fund families, and even for individual funds within a fund family. Many fund families offer mutual funds with no load fees. Others may have a variable load fee structure, such as 2% upon purchase (“front-end” or purchase fee) and 1% upon sale (“back end,” sales, or redemption fee ). In many cases, the back-end load fee will be waived if you hold the fund position for a certain minimum amount of time, which is generally two or three years.
Alternative Strategy: If your investment plans include mutual funds, you should favor no-load funds. Also, look for investment brokers that offer no-fee mutual funds. For example, TD Ameritrade has hundreds of mutual funds available for trading commission-free.
Still another alternative is to invest in exchange-traded funds instead of mutual funds. Load fees are unique to mutual funds but are not charged on ETFs. An ETF will give you similar diversification among hundreds of different securities, but they are generally tied to market indices, which is commonly referred to as index-based funds.
3. Expense Ratios
Expense ratios relate to mutual funds and ETFs and are something of a hidden charge because they take place internally. In other words, unlike commissions or account fees, they won’t appear on your monthly statement. Unless you research the fees charged by a fund, you may never know what its expense ratio is.
The expense ratio is comprised of a fund’s annual operating expenses. This includes 12b-1 fees, management fees, distribution fees, and other expenses. They’re commonly reported on the website of the fund family that offers the fund. The higher the expense ratio is, the lower your net investment return will be.
Alternative Strategy: Your first line of defense is to be aware of expense ratios for any funds you invest in. The second is to choose those that are on the lower end of the range. That range is typically between 0.20% to 1.00% per year. Some funds have expense ratios that are even lower. You should favor those with the lowest fees in their respective sector class. You should also be aware that ETFs generally have lower expense ratios than mutual funds.
Many ETFs issued by Vanguard, Charles Schwab, iShares and SPDR have expense ratios that are well below 0.20%. This is why these funds are favored by robo advisors and why they should be first choices for you as well.
You don’t need to open an account with the fund families to take advantage of their low expense ratio ETFs. Instead, you can choose to hold those funds in whatever commission-free brokerage account you decide to invest with. Precisely because they are low expense ratio ETFs they’re available through most brokers.
4. Investment Advisory Fees
These are annual fees charged by robo advisors. They compensate the advisor for creating and managing your portfolio. The fees are generally low to begin with, but that doesn’t mean you should assume the rate doesn’t make a difference.
With low fees to begin with, investment advisory fees obviously won’t be–and shouldn’t be–the main criteria for selecting a robo advisor. But it should always be a consideration if two robo advisors are offering similar service levels.
Alternative Strategy: Most robo advisors do charge an annual investment advisory fee. But that can range between 0.25% and 0.50% per year. You’ll help your cause by choosing those at the lower end of the scale.
For example, Betterment and Wealthfront charge an annual advisory fee of 0.25% on most accounts. And you can even find robo advisors that charge no annual advisor fee at all. An example is M1 Finance. Not only do they have no investment advisory fee, but they also allow you to choose your own investments, including individual stocks. It’s something of a hybrid between a robo advisor and a self-directed investment account, complete with fee-free investing.
5. Investment Management Fees
These are fees charged by traditional, human investment advisors. They typically start at 1%, but can be as high as 2% or more when other charges are included. They can take a big chunk out of your annual investment returns, particularly on a portfolio that’s conservatively invested.
A portfolio with an average annual return of 5% will be reduced to 3.5% if the advisor is charging a fee of 1.5%. It hardly seems worth paying an investment manager for that kind of net return.
Alternative Strategy: The best strategy for dealing with investment management fees is to work with a manager who charges either a flat fee or bills by the hour. This can be especially important if you have a large portfolio. For example, let’s say you have a $1 million portfolio. An investment manager wants to charge a fee of 1.25%, or $12,500 to manage the account for the year.
But another investment manager will do the job for a flat fee of $7,500. By using the flat fee manager, you’ll save $5,000 per year in fees, which will be the equivalent of a 0.50% improvement in your investment performance.
Still another alternative is to use Personal Capital. Using more automated investment processes, they provide hands-on investment management similar to traditional investment advisors. And they do it all for an all-inclusive annual fee of 0.89%. They may be only a little bit below the investment managers with the lowest annual fees. But it will still make a significant difference over the long term.
6. Surrender Charges
Surrender charges are fees that will be collected if you exit an investment before a specific amount of time has passed. They’re not common on most investments or investment brokers. But they’re very typical with insurance-related investments. That can include any type of cash-value life insurance policy, like whole life insurance or universal life insurance. And they’re especially common with annuities.
For example, an annuity may have a surrender charge schedule. It may include something like a 10% surrender charge if you liquidate your annuity in the first year, with the fee dropping by 1% per year thereafter. Only after 10 years will you be able to withdraw your investment from the annuity without having to pay the surrender charge.
The basic problem with a surrender charge is that, more than anything else, it limits your ability to get out of an investment you may not be happy with. You can withdraw your funds from the annuity, but only after the surrender charge has been applied. In the insurance universe, surrender charges function as something like an early withdrawal penalty- except the penalty percentages are much higher.
Alternative Strategy: The best strategy is to avoid annuities entirely. They’re complicated investments to begin with because they’re actually investment contracts you make with an insurance company. And they’re usually loaded with fees, of which surrender charges are only one. Some annuities even have provisions where the investment will revert to the insurance company upon your death, rather than going to your heirs. If you’re in an annuity and you’re not happy with it, you’ll need to follow a strategy to get out with the minimum amount of damage possible.
If you’re even considering investing in an annuity, discuss it first with a certified financial planner, CPA, or an attorney. Never rely solely on the representations of the insurance company representative. After all, he or she will get a commission upon selling you the annuity (which is yet another fee) and can hardly be expected to be objective.
7. Annual Account Fees
These are fees that are charged on some brokerage accounts but are more common with retirement accounts. That can include both employer-sponsored retirement plans and self-directed IRAs. The trustee or broker may charge an annual fee of anywhere from $50 to $200 or more.
An annual fee of that size may not make a material difference on an account with $500,000 or more. But it can have a significant impact on one with $10,000 or even $20,000.
Alternative Strategy: You may not have a choice when it comes to an employer-sponsored retirement plan, but you absolutely do with a self-directed IRA. Many brokers offer no annual fee on IRA accounts and those are the ones you should favor. It’s especially true if you’re choosing between brokers that offer commission-free trades. Even if the annual fee is only a small amount, it’s not worth paying if you can possibly avoid it. A fee of even $50 per year will add up to $1,500 after 30 years. Why pay that if you don’t have to?
8. Employer-Sponsored Retirement Plan Fees
Employer-sponsored retirement plans have a reputation–often well-deserved–for being packed with high fees and sometimes a lot of them. What makes it frustrating is that you don’t really have a choice. You have to work within the scope of the plan your employer has provided, and too often not enough thought goes into that decision. It can leave you stuck with a plan heavy on administrative fees, mutual funds with load fees, and even trading commissions.
Alternative Strategy: Unfortunately, employer-sponsored retirement plans are not democracies. You’ll need to work within the account assigned by your employer and with whatever investment options they offer.
But you can use a retirement plan robo advisor called Blooom to manage your account for you. Once you add it to your plan, it emphasizes use of the lowest cost investment options available in the plan. They charge a flat fee of $10 per month, and saving you just 0.25% per year in fees can make a big difference in the long-term performance of your retirement plan.
Final Thoughts on High Investment Fees You Need to Avoid
As you can see from the list above, investment fees are common in nearly every type of investing endeavor. Some, like mutual fund load fees and trading commissions, are easy to spot. But others, like expense ratios, investment management fees, advisory fees, and surrender charges, may be hidden in the fine print.
It’s your money and your purpose is to invest it to get a maximum annual and lifetime return. Eliminating (or lowering) investment fees is one of the most effective–and easiest–ways to improve your returns. Simply by making a few choices to go in a different direction, you can make dramatic improvements in your investment returns.
And that’s passive investment income of the best kind.