As an example, consider an analysis prepared by the U.S. Securities and Exchange Commission (SEC). An investor starting with $10,000, earning 4% return each year and paying just 0.25% annually in investment fees will accumulate $210,000 after 20 years.
But consider if that investor pays 1.0% in investment fees each year. On the face of it, the difference between 0.25% and 1.0% seems modest; both are relatively low when one compares different investment expense ratios. But even this small gap in rates adds up to a substantial difference in earnings over time. In an account that’s charged 1.0% annually, that $10,000 would grow after 20 years to be worth $180,000--or $30,000 less than the account that was dinged only 0.25% a year.
Fees Are Lower, but Still Hurt Performance
Investors are becoming increasingly aware of fees and how they ultimately affect the wealth they accumulate over time. Investment advisers and asset managers are reacting to the pressure and gradually lowering the expenses paid by investors through management fees.
Morningstar reported last year that the average mutual fund expense ratio is down from where it was five years ago. Their research found the average asset-weighted expense ratio was now 0.61% in 2015.
Any improvement is welcome. But as the SEC analysis shows, even low fees can take a big bite out of investment performance.
It’s true that investment fees are a necessary evil. Firms that build the platforms that help you put your capital to work in the markets need to earn something for their efforts--they’re in business to turn a profit after all.
And if you invest through mutual funds or with an investment adviser, you have to pay for the expertise they bring to the table.
While some of these fees are unavoidable, they can be more manageable in the hands of savvy investors who know how to use these cost-saving strategies.
Choose low-cost index funds or ETFs. These types of mutual funds are built to copy and track the performance of specific market indexes. While there are professional managers at the helms of these funds, their management fees are much lower than actively managed funds--when you’re just copying an index’s holdings, there’s less research, analysis and stock picking to do.
Work with a fee-based advisor. A fee-based advisor will charge an annual fee based on the value of all assets in an investor’s account (usually prorated on a quarterly basis.) There is a built-in incentive for the advisor to grow account values—when account values are higher, the advisor earns more money. With a broker, investor recommendations may be skewed toward investments that pay higher commissions to brokers looking to boost their income.
Negotiate the fee you pay. You don’t have to accept an advisor’s stated fee as the final cost you’ll pay to invest. Feel free to ask for a lower rate, especially if you have significant assets to invest. Some advisors will offer breakpoints or tiered management fees based on different levels of investable assets.
Avoid frequent trading. This is one of the biggest traps investors often find themselves in—they chase hot trends and top-performing managers, incurring transaction fees on top of missing most of the potential outperformance. The fees and the missed return opportunities reduce the power of compounding growth, one of the biggest influences on investors’ total return.
In fact, investment fees may be the biggest drag on the returns investors achieve. When fees are high, investments have to work harder—seeking higher returns by assuming greater risks. But if you can minimize the costs you pay to invest, you’re more likely to find achieving your investment goals becomes much easier and less stressful.