A major drag on investment returns is fees, the costs you pay for investment help in various forms. Some of them you probably know about, but some are much less obvious.
Taken together, fees add up to a lot of money out of your account each and every year. If you have $1 million invested, each 1% in fees costs you $10,000 a year. But it doesn’t stop there: Your advisor is likely to buy mutual funds on your behalf that charge another 1% or more.
Ten thousand here, ten thousand there and pretty soon we’re talking about real money. Moreover, every cent that leaves your portfolio immediately ceases working for you and instead begins to work for the money managers.
How can you turn this dynamic around? By questioning every fee you pay to ensure that you get your money’s worth. Here’s where to start:
1. Market friction
You might not realize it, but the narrower the asset class the less liquidity it has in the market, which is a fancy way of saying there are fewer buyers and sellers. That can lead to big gaps between buying and selling prices as you trade.
You can reduce this cost gap problem by sticking to widely held index funds and index ETFs. They normally trade within fractions of a cent, limiting this hidden expense.
2. Trading commissions
Trade enough and even reduced online commissions get to be a lot. If you buy and sell mutual funds, expect that fee to be $50 coming and going. Certainly, active trading is an expensive way to try to get ahead, if only because trading costs sandbag you from the start.
Instead, use commission-free ETFs and limit trading to periodic rebalancing as needed.
3. Costly advice
Financial advisors have a role, especially if you need help with setting up a retirement plan, budgeting or deciding between insurance products. What you probably don’t need is ongoing advice on what stocks to buy and sell. Research shows that most active managers struggle to keep up with their benchmarks.
The better course is to own a balanced portfolio that reflects your taste for risk and to rebalance it as needed, turning your selections gradually more conservative as you grow older.
4. Fund fees
Mutual funds are a grab bag of fees. Fees to the advisor. Fees to enter the fund. Fees to exit the fund. Fees to pay for marketing the fund to other people who are not already investors (seriously, this exists). Fees for coffee and staplers and secretarial help and phone systems, none of which helps your bottom line grow in the least.
Index funds will give you plenty of exposure to the markets at a tiny fraction of the cost of active mutual funds.
5. Tax expenses
If you invest in a taxable account, there’s little you can do wrong if you simply avoid buying and selling too quickly, thus triggering short-term capital gains taxes. A good CPA can help you keep your taxable accounts tax-efficient.
If you have an opportunity to save in a qualified retirement plan, however, save there first. Your money grows tax-deferred for years, a real boost when it comes to compounding returns.