Do you have any idea of the costs and fees associated with your investment accounts? The previous articles in this series have explored the difficulty of determining what things really cost. In discussing this issue with some friends, another frustrating cost question arose: “What does it cost to invest your money?” There was unanimous agreement that information about investment costs was often scarce and confusing. What fees are associated with investing? How do we find out?
Many people don’t know whether or not their accounts are being managed by anyone, and whether or not they are being charged. In this article, we’ll look at those investment accounts you may have. What exactly are you paying for? How much does it cost to have your money managed for you? Some investment vehicles, specifically mutual funds and ETFs, have “expense ratios.” We’ll look at those as well as 401Ks.
Is your account being managed?
If so, you are paying fees. And as we’ll see shortly, you are likely paying fees even if you don’t have a “managed” account. (Confused yet?) In a managed account, you sign an agreement giving someone permission to invest on your behalf. Sometimes fees in managed accounts are deducted from your account monthly, although quarterly is the industry standard.
You may have an arrangement where you’re paying a fee and the “management service” isn’t discretionary. This means that you may have a conversation with someone, at Schwab for instance, who gives you recommendations that you then evaluate in order to make your own decisions. This is a non-discretionary account (they can’t do anything without your permission.) So, while you are in charge of your investment choices, you still pay for the recommendations and expertise provided.
Finding the information
Investment management fees are typically deducted from your account on a quarterly basis. It is customary (though not mandatory) for you to receive an invoice for such services. To determine the percentage you are being charged for investment advice or management of the account, examine your statements from January, April, July, and October.
On the first or second page, you should see a beginning and ending value for the account. In that section, you will see any deposits, withdrawals, and fees (which are sometimes lumped under “expenses.”) If your fees are deducted quarterly, you can multiply this amount by four, then divide the value of your account. The result is the approximate percentage being charged for the management of your account.
Mutual funds, ETFs, and expense ratios
Even if you don’t have a “managed” account you may still be paying fees. All mutual funds and exchange-traded funds (ETFs) have expense ratios. Legal, administrative and management costs are components of the expense ratio.
Firms such Vanguard, Fidelity, iShares, etc. charge these fees in order to offer and manage the investment vehicle. These fees do not show up on your statements. You have to look for them. One of the easiest ways to find expense ratio information is to go to Google or Yahoo finance and type in the name or ticker symbol of the investment.
As a general rule, mutual funds, especially actively managed ones (as opposed to index mutual funds) will have higher expense ratios than ETFs. It is common for mutual fund companies to charge anywhere from 0.5% to 1.75% per year for their product. ETFs, being primarily indexed investments, charge 0.05% to about 0.75%. These fees reduce your investment returns and you never really know you’re being charged unless you investigate. Many people are unaware that their portfolios of mutual funds come with annual fees of almost 1%!
Think you don’t pay fees in your 401K?
I just did a quick survey of clients’ 401K statements. Not one of them contained expense information. 401Ks typically offer a selection of mutual funds from which to choose. On this list you can usually find the expense ratio information. Some larger companies can, and do, negotiate for lower expense ratios. It can be more challenging to find information on administrative, legal, and accounting costs of the plans. This information must be disclosed once a year, so you may need to ask, or dig through past mailings.
If your head is spinning by now, you are not alone. Common sense dictates it is better to pay less in fees, rather than more. All the fees add up, and this means less money for you, especially over the long haul. A mistake many investors make is assuming they are not paying any of these fees. To answer the question, “What does it cost to invest?” first we need to know what we are paying for. Once we identify these costs, we can make more informed choices about our investments.