How to Know If You Are Paying Too Much in Fees

Paying fees on your investments is a given. Here’s how to spot them and what to do about them.

Paying fees on your investments is nothing new. No one is immune from it – even high-net-worth individuals will pay fees on their investments (albeit at a sometimes smaller rate than most). However, investors with fewer assets who are more likely to invest in mutual funds (rather than work with a stock broker, for example) often pay high management fees on their investments.

Doing the Math

First, let’s see how mutual fund fees can erode investments compared to other, cheaper forms of the same type of investment. The difference can be seen in the following example from ETFdb.com: ETFs vs. Mutual Funds: Fees and Expenses. The example assumes an investment of $100,000 was made over the course of 30 years with a 6% rate of return. A mutual fund might charge about 1.5% in expenses per year while the ETF might cost around 0.35%. After 30 years, the value of the mutual fund will equal $374,532 and the ETF will have grown to $520,098.

This math alone should give investors pause to look at the management fees for each of their investments and see if alternate investments can be acquired at a reduced cost.

According to a Wall Street Journal article, investors can choose a more “bare bones” approach, with financial advisors doing less “handholding” and only providing the basics for their clients. These types of plans can include household budgets, projections of retirement needs, and a model portfolio of stocks and bonds. The money management side of it is either done by the investor themselves or through other intermediaries at a reduced price.

Other Considerations

Besides the management or advisory fees, investors need to educate themselves about other sales and administrative fees often tacked onto the funds themselves. For example, a 12b-1 fee essentially gives the fund manager permission to collect a fee to pay for things like marketing and other related expenses. Some of these fees can range from 0.25% to 1.0%.

Also, sales loads or front-ended loads are often added to the purchase of a mutual fund, acting as a one-time commission paid directly to the broker who sold you the investments. These can also be quite high (sometimes beyond 5.0% or higher according to RBC Global Asset Management) and will make a large dent in your initial investment.

The Micro Costs of Day Trading

It’s likely that many investors do not consider trading costs. Any day trader or DIY investor knows that each time a stock, bond, or any investment is traded a fee will be paid to buy or sell that investment. Investments with a longer-term holding strategy can help reduce those costs, which are inevitably passed down to you by the fund manager. They cut into your investment and, ultimately, your future returns. Also, the investment strategy itself can be a determining factor of fees.

For example, international funds or other funds that don’t invest in all blue-chip companies might charge a larger expense ratio than a fund investing in known companies. Also, an index fund, which simply attempts to mirror the market, will be cheaper than a more actively managed fund in which stocks are cherry-picked based on the chosen strategy.

Knowing the Facts

Overall, it’s best to look at the fine print and prospectus of each fund you or your broker are considering for your portfolio. Ask questions and make sure you have the facts before making a selection. Often, other alternatives are available that will help curb your costs and save you money in the long run.

Image courtesy of David Castillo Dominici at FreeDigitalPhotos.net