This is an article part of the quick hit series
When you invest in anything through a 3rd party (a broker, trading platform etc), typically there is a fee that they will charge. There are no escaping fees, typically though in the last few years, a lot of online brokerage platforms have moved zero fees for trading. However, there are a number of fees that you need to be aware of particularly because it impacts your returns. So let’s first talk about why we care about this and then we will go into a quick overview of the different types of fees.
Why do I care about this?
It’s very simple – any fees you pay eats into your returns. For eg. let’s say you have invested in a mutual fund that has a 1% fee. If you earn a 6% return, then you lose 1% on the expenses thereby netting a 5% return. On the other hand, if you invest in a mutual fund that has a 0.1% fee which also returns 6%, then your returns are 5.9%. This is a very simplistic example and of course, you have to consider other factors other than fees. But this is one of the factors to look into. When you have only $1000 invested, you may feel like shaving off $10 (1%) does not feel so bad. But when you have $1M invested, shaving off $10,000 in fees might feel a bit pricey.
As I said you have to consider other factors too – one of the biggest being, the actual returns. The folks who are selling these products will always argue that if they are charging more fees, it’s because they promise higher returns. And that might be true but you need to keep your eyes wide open.
Let’s examine some of the types of fees:
Expense ratios
If you have been a reader of this blog, you know I am a big advocate for passive index funds to invest in the stock market. But whether you invest in passive index funds/ETFs or active mutual funds/ETFs, one of the things you need to know and look for is the expense ratio. Let’s take a couple of examples:
- Passive Index fund example – Vanguard Total Stock Market Index Fund Admiral Shares (VTSAX) https://investor.vanguard.com/mutual-funds/profile/vtsax . If you click the link, you will see it has an expense ratio of 0.04%. Note that it also shows a 10 year return of 14.71% reflective of the stock market boom in the last decade.
- Active index fund example – Fidelity Advisor Value Strategies Fund – Class A https://institutional.fidelity.com/app/funds-and-products/266/fidelity-advisor-value-strategies-fund-class-a-fsoax.html . If you click the link, you will see it has an expense of 1.03%. Note the average annual returns after sales charges range from 10.28% to 12.04% depending on the time of the year.
Please note that the above 2 examples are not apples to apples comparisons because the Vanguard fund is a total stock market fund and the Fidelity fund is a mid cap stock market fund. But it is important to reflect on the fact that if you had $10,000 10 years back and you did not care about which fund to invest in, if you invested in the above-mentioned passive fund, you would have gotten higher returns both due to a better performance as well as lower expense ratios.
Vanguard has been at the forefront of funds with very low expense fees and have forced the industry to consider funds with rock bottom expense ratios and have recently spawned funds with ZERO fees. For eg, Fidelity recently launched ZERO fee funds (https://www.fidelity.com/mutual-funds/investing-ideas/index-funds)
Financial advisor fees
If you decide to use a financial advisor, the first question you need to ask them is how they get compensated? Do they charge a fixed fee (flat rate), charge by the hour, monthly retainer or commissions based on assets under management (AUM)? In general, people who read my blog know that I am not a proponent of moving to financial advisors who charge commissions based on assets under management. That is a topic for a different blog post but it is important to know these fees as you enter into a relationship with a financial advisor.
Trading platform fees
If you are using online brokerages, you know just a few years ago, before the advent of Robinhood, you had to pay a fee of around $5 for each trade you made. Years ago, it used to be even more. After Robinhood came into the picture, they decided to not charge any fees for the trades. Now there is a bit of controversy surrounding this saying they make money in a different way but ultimately for the average buy and hold investor it does not matter and they have benefited from this. However, it’s important to note other asset class trading platforms charge fees. For eg. Fundrise for investing in crowdfunded real estate or if you wanted to invest in crypto currency through Coinbase. All of these platforms charge fees. In addition, the robo-advisors like Wealthfront, Betterment etc also charge a fee for managing your portfolio completely.
Note that all these fees are over and above the expense ratios or even sometimes the financial advisor fees. So they can all add up.
Concluding comments
Knowing the fees sometimes feels like reading the fine print. But these have become easier to find and you just need to be more aware of these fees. Ultimately, don’t ever feel shy to ask anyone how they make money. Ultimately, everyone is out to make money off your investments which is perfectly fine. You just want to make sure you get the best bang for the buck.
Thank you for reading and I wish you luck in your financial journey.
Disclaimer: I am not a financial advisor and all the information in my articles are from my personal experience and are for informational and educational purposes only. Please consult with a financial advisor or CPA for professional advice.
