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High fees can take a bite out of your portfolio returns, but the good news is that it’s becoming cheaper to invest.
Financial services firms charge clients a fee to invest their funds, typically withdrawn from their investment assets. When costs are high, they eat into returns over time.
Consider that over a 20-year period, an investment portfolio that’s generating a 4% annual return but assessed a 1% fee could lose nearly $30,000 more than a similar portfolio with a 0.25% annual fee, according to the U.S. Securities and Exchange Commission.
Indeed, costs are going down as asset management firms compete for clients’ dollars. Expense ratios on equity mutual funds averaged 1.04% in 1996, according to the Investment Company Institute. They tumbled to an average of 0.5% in 2020.
“In the retail fund market where products compete to be bought… costs have never been lower. Investors can get a globally diversified portfolio for less than 10 basis points, which is terrific,” Micah Hauptman, director of investor protection at the Consumer Federation of America, said.
Why has it become cheaper to invest?
Some experts believe a major catalyst behind this trend is an increased awareness among individual investors, leading many to become more price conscious.
“Consumers have learned that costs are directly, or inversely, correlated to return,” Ron A. Rhoades, director of the personal financial planning program in Western Kentucky University, said. “Basically, higher fees and cost equals lower returns. A lot of academic evidence backs that up.”
Rhoades said the cost of investing has also fallen over time due to the rise of fiduciary investment advisors, who are required to act in their clients’ best interest and aim to keep expenses low, as well as online robo-advisors that offer financial services at a cheaper rate.
“That’s put a lot of pressure on the asset management industry to come up with lower-cost solutions because that’s what investment advisors are requiring,” Rhoades said.
Increased competition, notably in the ETF market and between direct-sold mutual funds, has also contributed to lower investment costs, Hauptman said.
An additional catalyst toward the declining cost of investing, Rhodes added, are mandates from the Labor Department that went into effect more than a decade ago.
These rules require retirement plan service providers to disclose fees to plan sponsors and called for employers to issue fee disclosures to individuals participating in workplace retirement plans. This led savers to pay closer attention to costs, Rhoades said.
How investors can be mindful of their expenses
Investors need to assess their fees in relation to the value they are receiving from their investments, Hauptman said. Most financial advisors charge clients based on how much money they manage for them, which is typically about 1% of assets. Some financial advisors may charge a flat fee or bill by the hour.
“It’s important for investors to not just look at one piece of the investing puzzle to the extent that they’re getting products and services,” Hauptman said. “They need to consider all of the costs that they’re paying, because all of the costs will ultimately erode their total returns over time.”
Sheryl Garrett, a certified financial planner and founder of the Garrett Planning Network, advised newer investors trading individual securities to do so minimally, and keep the rest of their investments “plain vanilla” in order to reduce the amount of recurring transaction costs.
Here are three steps to keep a lid on investment fees:
Check your expense ratios: Do some comparison shopping as you look through mutual funds and ETFs. Investment fees have come down considerably in the last couple of decades, but fund managers may charge more for eclectic offerings, such as strategies that focus on alternative investments.
Watch for other costs: If you’re investing through a brokerage account, keep an eye out for transaction fees, which can be very painful for the most active investors. Some firms also charge for broker-assisted trades. In a 401(k) plan, you could face costs in the form of administrative expenses – and those are in addition to the fund fees you pay.
Know how your financial advisor is paid: Ask up front whether your financial advisor is a fiduciary. Does your advisor charge based on assets under management, or does he offer a flat fee? Does he receive any commissions for products he recommends to you? Get these details in writing and be sure you understand them before you hire this professional.
Ultimately, the best investment is for individuals to become self-educated about their finances, Garrett said.