Investment Fees: How Much Should They Cost and How to Minimize Them
When you’re focused on how well your investments are performing, it’s easy to overlook hidden fees that come with investment services. Investment fees are charges you pay for the services of your investment accounts and financial professionals. But how much should investment fees cost, and how can you tell when you’re being ripped off? Here’s a brief overview of how investment fees work, as well strategies to minimize them to help you keep more of your investment returns over time.
What are the different types of investment fees?
Investment fees play a major role in your portfolio’s performance. Generally speaking, minimizing fees tends to maximize returns. But in the wide world of investing, these fees can take a lot of different forms:
- Expense ratios are calculated as a percentage of your investment in the fund and are charged annually whether you make or lose money.
- Transaction fees apply every time you buy or sell an investment.
- Advisory fees are typically charged quarterly based on the value of your portfolio.
- Account fees depend on the type of account and services used.
Being aware of the fees you pay is important to investing wisely. Let’s take a look at just how much investment fees should factor into your decision-making.
How much should investment fees cost?
Investors should carefully “view the fees they are paying in relation to the value they’re receiving,” says Nathaniel Donohue, financial planner and partner at Consilio Wealth Advisors. Fees play a huge factor in your investment decision-making. “There are very few things you can control in the investment world, but you can control how much you pay.” Minimize fees, and you can maximize performance.
In order for an investor to determine whether certain fees are worth their cost, they have to be able to understand the value they’re getting. For instance, let’s say you’re hiring a financial advisor. Most financial advisors charge based on how much money they manage for you, and that fee can range from 0.25% to 1% per year.
If you’re looking for someone to do nothing more than manage your portfolio, then a fee closer to 1% is on the higher side. You’d need to keep a careful, knowledgeable eye on your portfolio to know if its performance outweighs that 1% cost. But if your financial advisor provides additional services like tax advice, saving for your kids’ education, or estate and retirement planning, then that 1% number is likely well worth the value you’re getting. Here’s our guide to finding a financial planner who won’t rip you off.
Understanding how your investments perform
Donohue explains how the most common place people invest in the stock market is in U.S. large company stocks (aka U.S. large cap), which is often benchmarked against the S&P 500 index. This index tracks the 500 largest companies that are publicly traded in the United States. Because of how efficient this area of the market is, money managers rarely outperform this index, especially over a long period of time. As a result, investors are wise invest in an S&P 500 index or ETF. These index funds/ETFs are less expensive and perform directly in line with the benchmark, resulting in a higher net return for investors.
So what does this mean for evaluating your investment fees? Well, since it’s “next to impossible” for an investment manager to outperform the S&P 500 benchmark, high fees at or above 1.5% are almost certainly a rip-off.
Other asset classes, such as U.S. small companies, emerging market, real estate, or private equity, all invest in other markets, meaning they use different benchmarks than the S&P 500. These investments can be more volatile, and there are managers who historically have performed well relative to their respective benchmark, according to Donohue. In this case, say you’re paying an above-average fee at around 1-2%. If your fund is capturing a rate of return well above the benchmark, then that above-average fee is most likely worth the tremendous value you’re getting.
Donohue notes that naturally, there are going to be managers costing 1-2% in fees that will still underperform. With that high a percentage and that low a return, you’re not getting a worthwhile deal.
The point being that investors should understand how their investments perform, relative to the appropriate benchmark, when examining performance received and fees paid. If investors are ever unsure, they can default to investing in the benchmark index fund/ETF because they can control keeping their costs low. As Donohue puts it,“control the controllables.”
How to minimize investment fees
Here are some tips to make sure your investment fees are worth paying:
- Stick to low-cost index funds and ETFs. Actively managed funds have higher expense ratios.
- Buy and hold investments long-term to reduce transaction fees.
- Seek low or no advisory fees from automated digital advisors.
- Choose tax-advantaged accounts like 401(k)s that may have lower fees.
- Meet account minimums and consolidate accounts to potentially lower or waive fees.
- Review fees annually and assess if you’re getting value for the costs.
The bottom line is that as an investor, fees are one of the few things in your control. Minimizing your investment costs means more money working for you over time. Do your research and seek fee transparency from financial institutions. And if you’re investing in a financial advisor for the first time, be sure to read up on the difference between fee-based vs. fee-only advisors.