Pay attention; don’t let fees eat your investment returns
October 20th, 2021 by D.C. Poc
The title of this article sums up exactly what we’ll be doing here. I truly hope everyone can gain a solid understanding of all the fees they pay on investments, because as the value of your assets increase, the fees become very, very noticeable. Paying 2% total fees on $50k is one thing, but try doing it on $2MM. In this article we’re going to explain the various types of fees, where you can expect to pay them, and how you can avoid them. We will also break down the numbers so you can understand the impact. I know, you came here looking for the numbers, so we’ll give them to you!
Types of fees you can expect to see
The financial services industry is famous for inventing hidden fees that take money from the investor. Below are the common ones we’ll be talking about.
Expense Ratio (ER) - these are the built-in expenses associated with a fund. They range from 0 to ridiculous. It isn’t uncommon to find ERs of 1.5%. Yes, that is 1.5% right off the top of your investment, even if you don’t have any appreciation. Unacceptable at 1.5%.
Assets Under Management (AUM) - this is a fee charged by the broker as a percentage of all invested assets. For example, you have $1MM in your account. The broker charges 1% AUM. You will pay the broker $10k per year regardless of investment outcome. This is in addition to ERs. Remember this when your broker invites you out on his yacht because there was a good chance your $10k was his down payment and your remaining fees will help make his monthly payments!
Administrative Fees - these are typically more acceptable, and I guess justifiable in some ways. Some brokers, typically those offering employer plans, charge periodic administrative fees. The most common figures are low, something like $25 per quarter, $50 per year, etc. As your balance increases, these fees become pretty obsolete and won’t really trip your radar.
Front Load Fees - these are fees charged as a percentage up front. A common front load is 5.75%. If you buy $100 of a fund with a front load of 5.75%, you’re only getting $94.25 in funds. That’s a bad way to start an investment. Oh by the way, in 2021, with all of the low cost funds that are available, there is no reason to ever buy a front load fund.
These are the big ones that you can expect to find pretty easily. If you search high and low, you’ll find other cleverly named fees. I’m just not willing to scour the dark corners of the internet to find some shady broker that invented a new fee that ultimately takes advantage of an everyday hard-working American. So be warned, these fees may be disguised better than Clark Kent in Superman.
How to avoid the dreadful fees
I often get asked about the best way to cope with high fees. My response is simple - don’t cope with them, simply avoid them. I know this isn’t always possible as 403(b) and 457(b) plans are often the biggest culprits, and these more commonly have fees in the range of .25-1 which is acceptable depending on the participants tax rate. But if you have funds in an IRA, Roth IRA, or brokerage account and are paying high fees, the simplest thing to do is transfer the account to a low-cost brokerage. NOTE: conduct research before doing this. You can stumble into unintended tax consequences as well as some other things. If assets can be transferred “in kind” to avoid this, they should.
I’m not going to get into “name calling” in this article. I could easily name 20-30 companies that charge insane fees that are predatory to the consumer. A little research on your part can also bring this to light. I’ll cast a wide net right now and confidently state that insurance companies that sell investment products will be the biggest offenders. If you spot that, run. The one notable exception to this is TIAA Bank, which is famous for providing high-quality, low-cost investment products to teachers, mostly.
Another way to spot the shady characters is to ask them about their fees. If they start sending you 100 page disclosures and avoid the obvious questions, the fees are likely high. You can skip the 100 page disclosure at this point. Best advice - research, research, research.
The math (I’m sick to my stomach)
Okay, let’s break down the math on these treacherous fees. Bob and his wife get married in college, and shortly thereafter open Roth IRAs. They invest $6k each ($12k total) annually from Age 22 until 57 when they are planning to retire. Assuming a 5% annual return, let’s look at the difference between 2%, 1%, and .1% in fees.
Yup, you read the chart right, the difference between broker 1 and broker 3 is approximately $335k. Heck, even broker 2 and broker 3 have a difference of $227k, and 1% in fees isn’t uncommon. Who wouldn’t want an extra $227-335k in their Roth IRA? Are you sick yet? I am. No one, and I mean no one, should be paying 2% in fees. Friends don’t let friends pay 2% in fees. AJ Sheff and I started Wealthy Idiots to ensure that as many people as possible understand fees and avoid them.
Run… just RUN!!!
The moral of this story is simple - do your research and ensure you are minimizing the fee impact on your investments. As mentioned before, Vanguard, Fidelity, and Schwab are all great choices for low-cost funds. There are many more, but giving them all a shout out would minimize the space for our awesome content! Happy hunting.
D.C. joined the Marine Corps right out of high school. When he left active duty, after 5 years of service, he quickly earned a bachelors degree and an MBA. He got his first private sector job at a modest salary and quickly worked his way up through promotions. Once he started making decent money ($38k at the time) he quickly realized he needed to learn how to save to secure his future. After nearly ten years of research, he wants to share his knowledge and financial best practices so more people can become Wealthy Idiots!