Whether you’re investing in mutual funds, index funds, exchange-traded funds (ETF), or any other type of investment, it’s important to understand the fees you’ll be paying for each.
Paying high fees on your investments is like pouring water into a leaking glass; it’s that much harder to accumulate the resource you need.
Here’s a quick example: Your starting balance is $1,000, and your assets go up by 6% in a year. But if you pay 2% in fees, you’ll only get to keep 4%. That means you’ll earn $60 in returns, but after paying $20 in fees, you’ll only have $1,040, not $1,060.
While this may not sound like a big deal at first, this shortfall can compound in losses over time in the same way that your assets can earn substantial compounded returns over time.
So, every year you earn a return, you’ll be losing money not just on that year’s returns, but also on the returns you’ll receive on those returns, in perpetuity until you withdraw your investments.
High fees can cost you thousands — even hundreds of thousands of dollars — in lost investment assets over time.
How fees affect your returns
Take a look at this example provided by NerdWallet: An investor puts $500 per month into a brokerage account every year for 30 years, depositing a total of $180,000 and earning a 7% average annual return. Here’s how different investment fees would impact the investor’s returns:
Though paying 2% each year may seem miniscule at first, you can see how those fees add up over time. In this example, it would equate to more than a whopping $178,000 over 30 years.
Fortunately, there are good low-fee investment options out there. You just have to know what to look for.
Understanding investment fees
To find out how much a brokerage or advisor charges in fees, take a look at their website or ask for a prospectus before you begin investing.
If you are already working with an investment firm or provider, then look at your account statements, earnings statements, or any product or disclosure documentation provided. Contact your provider if you have trouble locating or understanding the fees associated with your account.
Common investment fees
According to a report by the Investment Company Institute, the average mutual fund expense ratio was 0.55% in 2018. At the same time, the average expense ratios for index equity ETFs was 0.20% and index bond ETF were 0.16%.
Depending on the type of investment, you may be charged the following fees:
Brokerage fees: Any fee that your broker charges you, whether for purchases, sales, consultations, or negotiations.
Advisory or management fees: Some advisors charge fees based on a percentage of assets that they manage, others assess a flat fee, either annually or when they provide services (like developing a financial plan for you), and others earn commissions for executing transactions.
Load fees: These are paid to the investment professional who sold you the investment. Front-end loads are charged when you put money into a fund. Back-end loads are charged when you take money out of your account.
Distribution and service (12-b-1) fees: Some mutual funds also have annual 12-b-1 fees, which cover operational and marketing expenses for the fund.
Trade or transaction fees: These are the fees that are charged every time you buy or sell an investment. Since ETFs are traded like stocks, you may have to pay a small commission every time you buy shares. However, many online brokerages now offer no-commission trading on ETFs, so it is possible to avoid these costs.
Administrative expenses: This is the amount charged to manage your investment, that is, to select the investments, buy and sell them, report on performance, and pay all the people who are involved in running the fund. It’s subtracted every year from your investment returns.
Investment fees make a big difference over time
It may seem that a few dollars here or a couple of percentage points there is nothing to worry about, but fees can greatly affect your ability to build assets.
Let’s look at what would have happened if you invested in one of the best stocks of all time 20 years ago — but paid very high fees for the privilege.
Let’s go back to 1997. You’re meeting with a high flying investment manager who has a hot tip for you. It’s Amazon, a company that most people haven’t even heard of yet, and they’re working on a platform to sell books online. “Sure, sounds good,” you say.
Unfortunately, there’s a catch: The investment advisor demands hedge-fund-like fees: a 2% annual fee and 20% of the annual profits. This arrangement will last for 20 years, and it will provide the bulk of your investment nest egg. This is how the billionaires invest, the advisor tells you; This is how you make money for a house in the Hamptons.
So, you give the advisor $10,000 and, 20 years later, you end up with $1.6 million. Nice, right?
But wait, if you had paid no fees at all, your investment would be worth more than $9.4 million. Fees have eaten up more than three-quarters of your nest egg. If anyone’s buying a beach house in the Hamptons, it’s your advisor, not you!
Find low-fee ETFs with Threadvest
If paying low fees is your top priority when it comes to investing, then Threadvest’s ETF Miner can help you quickly and easily search for low-cost ETFs that also meet other important criteria, such as the fund’s size, bid/ask spread, and how long it’s been around.
Our technology pairs simple and intuitive ETF search tools with industry-leading data to provide insights for better, more informed investment decisions.
Make sure you’re keeping more of what you make with your investments by checking out lower-cost ETFs that meet your needs with Threadvest.