Don’t Put The Cart Before The Horse

Today I thought I’d touch on a funky subject – FEES. As an Advisor, I often get asked about fees. So let’s discuss all the different types of fees that are likely built into your typical investment account – and yes, you should be concerned and ask about all of them, always. 1. Expense Ratio or Internal Expenses It costs money to put together a mutual fund. To pay these costs, mutual funds charge operating expenses. The total cost of the fund is expressed as an expense ratio.

  • A fund with an expense ratio of .90% means that for every $1,000 invested, approximately $9 per year will go toward operating expenses.
  • A fund with an expense ratio of 1.60% means that for every $1,000 invested, approximately $16 per year will go toward operating expenses.

The expense ratio is not deducted from your account, rather the investment return you receive is already net of the fees. Example: Think about a mutual fund like a big batch of cookie dough; operating expenses get pinched out of the dough each year. The remaining dough is divided into cookies or shares. The value of each share is slightly less because the fees were already taken out. 2. Investment Management Fees or Investment Advisory Fees Investment management fees are charged as a percentage of the total assets managed. These types of fees can often be at least partially paid with pre-tax or tax-deductible dollars. Example: An investment advisor who charges 1% means that for every $100,000 invested, you will pay $1,000 per year in advisory fees. This fee is most commonly debited from your account each quarter; in this example, it would be $250 per quarter. Many advisors or brokerage firms charge fees much higher than 1% per year. In some cases, they are also using high-fee mutual funds in which case you could be paying total fees of 2% or more. It is typical for smaller accounts to pay higher fees (as much as 1.75%) but if you have a larger portfolio size ($1 Million or more) and are paying advisory fees in excess of 1% then you better be getting additional services including, aside from investment management. These might include comprehensive financial planning, tax planning, estate planning, budgeting assistance, etc. 3. Transaction Fee Many brokerage accounts charge a transaction fee each time an order to buy or sell a mutual fund or stock is placed. These fees can range from $7.95 per trade to over $50 per trade. If you are investing small amounts of money, or your advisor is “churning” over your portfolio, these fees add up quickly. Example: A $50 transaction fee on a $5,000 investment is 1%. A $50 transaction fee on $50,000 is only .10%, which is minimal. 4. Front-End Load In addition to the ongoing operating expenses,  an “A share” mutual fund charges a front-end load, or commission. Example: If you were to buy a fund that has a front-end load of 5%, it works like this: You buy shares at $10 per share, but the very next day your shares are only worth $9.50 because 50 cents per share was charged as a front-end load. 5. Back-End Load or Surrender Charge In addition to the ongoing operating expenses, “B Share” mutual funds charge a back-end load or surrender charge. A back-end load is charged at the time you sell your fund. This fee usually decreases for each successive year you own the fund. Example: The fund may charge you a 5% back-end load if you sell it in year one, a 4% fee if sold in year two, a 3% fee if sold in year three, and so on. Variable annuities and index annuities often have hefty surrender charges. This is because these products often pay large commissions up front to the people selling them. If you cash out of the product early the insurance company has to have a way to get back the commissions they already paid. If you own the product long enough, the insurance company recoups its marketing costs over time. This the surrender fee decreases over time. 6.  Annual Account Fee or Custodian Fee Brokerage accounts and mutual fund accounts may charge an annual account fee, which can range from $25 – $90 per year. In the case of retirement accounts such as IRA’s, there is usually an annual custodian fee, which covers the IRS reporting that is required on these types of accounts. This fee typically ranges from $10- $50 per year. Many firms will also charge an account closing fee if you terminate the account. Closing fees may range from $25 – $150 per account. Most of the time if you are working with a financial advisor that charges a percentage of assets these annual account fees are waived.   A few notes on fees (and my personal opinion): People should worry more about value received rather than amount paid in fees. For instance, if your target portfolio return is 10% and you invest in a private equity fund which returns 90%, of which the manager keeps 80% – you get 10%. Who cares what the manager made? Are there cheaper investment options on there? Sure! But you chose this one and this one got you to your goal. Additionally, if you still have a financial advisor who ONLY advises you on investments – what are you actually doing? Go out and find someone who can offer you comprehensive financial planning. Many times, they will actually be saving you money on fees and in many other ways as well. I often say that I save my clients more money than I make them which is what keeps them wealthy!