Whether your investment portfolio consists of a 401k or multiple brokerage and retirement accounts, it is important to understand the fees associated with your investments which can dramatically lower returns over the years.
Fees can be hidden and difficult to identify, but here is an overview of potential fees to watch for:
For 401k accounts, there are typically fees charged by the plan provider to administer the plan. This will vary by plan and can be found in the plan documents. Brokerage accounts may also have various account service fees, so check the fine print for more details. Sometimes these are waived if you opt-in to electronic delivery and or meet certain account minimums.
When it comes to fund fees, ETFs tend to be lower cost than mutual fund fees. Most ETFs are passively managed index funds, while most mutual funds are actively managed funds although the reverse also exists. Actively managed funds will have higher fees, but fees will also vary depending on the underlying assets. It is worth noting that higher management fees do not denote a better-performing fund, so don’t assume you’re getting what you pay for.
The expense ratio is the annual fee that ETFs and mutual funds charge their shareholders. It is expressed as the percentage of assets deducted for fund expenses such as management fees, administrative fees, operating costs, and all other asset-based costs incurred by the fund. Mutual funds also include 12b-1 fees in the expense ratio, which ETFs do not have. What is not included in the expense ratio of a fund is the cost to trade the fund itself.
The expense ratio is accounted for in the performance of the fund since the costs are charged directly to the fund and not to the investor.
The expense ratio will be higher for an actively managed fund when compared to a passive index fund counterpart since the management fees are higher for active management. It is also important to understand the difference in the underlying asset classes of a fund as the type of underlying asset and its liquidity will also affect the fund cost. When it comes to index funds, highly liquid asset classes like U.S. equities will have much lower cost than small cap or international stocks which are less liquid.
Mutual Fund Specific Fees:
These mutual fund fees are charged annually and are considered to be an operational expense associated with a fund’s “marketing and distribution.” This could be anything from paying brokers to sell the funds or providing sales incentives. These fees are included in a fund’s expense ratio meaning the higher the 12B-1 fee, the higher the expense ratio. Investors can locate more information about these particular fees in a fund’s prospectus.
Front-End Load Fees
Front-end load fees are paid out to a broker in the form of commission when he or she sells a mutual fund. When an investor purchases a front-end load mutual fund, a percentage of their investment (usually 2% to 5%) goes to the broker. For example, if an investor pays $15,000 into a 2% front-end load mutual fund, $300 goes to the broker and $14,700 of the investor’s money goes into the fund. Front-end load mutual funds are usually “Class A” shares.
Back-End Load Fees
Also known as a deferred sales charge or DSC, back-end load mutual funds charge a penalty fee if you sell your shares within five to ten years. Fees are highest within the first year of purchase, and decrease each year until the end of the agreed-upon holding period. Back-end load mutual funds are usually those denoted as “Class B” shares.
Despite a trend of more brokerages offering free transactions, transaction fees still exist when buying and selling investments. The price range of transaction fees varies, and it should be an expense to keep track of if you make lots of transactions over time. Remember that this cost to trade is not included in the expense ratio.
The bid-ask spread is a truly hidden cost to trading and is referred to as an implicit cost. This is the difference between the price to buy a security and to sell a security, which are not the same. Highly liquid securities will have very tight spreads, making this cost minimal, but it is important to pay attention to the liquidity of the fund. Two important factors that affect liquidity are the underlying asset class of the fund and also the size of the fund itself. There are also other implicit costs to trading that can be affected by the size or the trade and how it is executed. These can add up in comparison to the explicit costs like a transaction fee.
Want an Advisor? Commission versus Fee-Only
If you’re looking for a little extra help with your investments, keep in mind that not all financial advisors are the same.
Some advisors are commission based. These types of advisors, known as investment brokers, make money through the commissions associated with investment transactions. An investment broker buys and sells securities within a clients’ account. The frequency and volume of trades can increase a broker’s commission – and end up costing the client a lot of money.
Fee-only registered investment advisors (RIAs) charge a flat hourly or annual rate for their services. RIAs have a fiduciary responsibility to act in their clients’ best interests. Unlike investment brokers, they provide advice and make transactions without taking commission-based compensation. They tend to use low-fee investments, including low-cost no-load mutual funds, individual stocks and bonds and investments that do not have 12B-1 fees.
Keep in mind that there is a major difference between fee-based and fee-only advisors. Fee-based advisors charge a fee to clients but also take commissions from mutual fund companies, insurance companies and brokerage firms. When shopping around for an advisor, be sure to ask how they are compensated.
Discover how much your mutual fund fees are costing you through Personal Capital’s Fee Analyzer. Sign up for Personal Capital and link your investment accounts to the Dashboard. Then run our Investment Checkup and click “Costs” for an overview of annual fees.