Do you know how much your investments cost and, more importantly, should you care? After all if your returns are enough to achieve your financial goals isn’t that all you need? It turns out that the costs of your mutual funds, retirement plan choices, and other holdings are important to monitor. Whether it’s shopping for clothes or kitchen supplies, you may think you get what you pay for. With investments studies show that on average the more you spend, the poorer your investments perform. Unless you’re willing to delay financial independence in the name of paying higher fees, I recommend you read on.
One way to categorize investment costs is the timing. When do you have to pay the fees? Is it an upfront sales charge, an ongoing fee, or a cost at the back end? We’ll look at these three times and discuss common fees, so you can be prepared to look for them before you make an investment decision.
Upfront sales charge. The classic example of this are mutual funds that have an upfront or front-end load charge. If you look at your investment statement and you see the letters A, B, or C after the mutual fund name, then it’s likely there’s a sales commission somewhere along the way. A shares are the most common and traditionally involve a charge that can be 4 percent or more. If you put $10,000 into an A share with a 4 percent load, then your investment will be worth $9,600 after the charge is applied. Some A shares can be reduced or waived loads if your investments meet certain minimum levels. Check with your brokerage firm to be sure what the cost is.
Some may regret that they have paid commission on their investments, but once invested resign themselves to holding it because they’ve already paid the fee. Don’t let inertia or the sunken cost fallacy keep you in an investment that doesn’t make sense for you. Financial products with upfront costs often have ongoing fees that are higher than reasonable alternatives. Make the best decision for your finances going forward.
Ongoing fees. Almost every investment has some level of an ongoing fee. Even bargain basement mutual fund giant Vanguard has expenses. But there can be quite a variance. If you perform an internet search of the five letter unique ticker of your mutual funds or ETFs, you can see the costs. As an example, look up Vanguard 500 (ticker is VFINX) on the Morningstar page to see it has an expense ratio of 0.14 percent per year. In comparison, look at the Rydex S&P 500 A fund (there’s that A share) with a ticker of RYSOX with a cost of 1.58 percent annually. Plus it has a maximum upfront sales load of 4.75 percent.
Sometimes it can take more digging to find out the fees, particularly if it’s an annuity, cash value life insurance policy, non-traded security such as a private real estate investment, private equity, or venture capital investment. Other charges that can be hard to determine are the sales commissions and other fees that the mutual fund or ETF pays when they buy and sell stocks and bonds, and also the tax ramifications that are passed down the investor. If you have a mutual fund with a 100 percent turnover, then the fund manager is selling the equivalent of the entire portfolio in a single year, which can have tremendous tax consequences.
Back-end fees. These can take the form of a sales charge with a mutual fund, generally B or C shares. Generally they decrease over the years that you hold the investment. Insurance and annuities with an investment component generally have back end fees, which are often termed surrender charges.
Assuming you have researched costs, how do you know whether they are reasonable? As a rule of thumb, you want to avoid investing into vehicles that charge an upfront or back-end fee. I call this category of costs “change your mind fees.” If an investment is not working for you, you want to be able to vote with your feet without being out a significant percentage of your initial investment. For ongoing expenses, with most mutual funds and ETFs they should be under one percent annually with many good options available for less than half of that amount. By knowing and smartly minimizing your upfront, ongoing, and back-end investment costs, you can make a significant difference over your investing life.