What’s the “right” amount to pay for an investment? Aren’t investments free or nearly so?
You might be surprised to learn that what you pay for your investments can vary dramatically, and not always for good reasons. While we’re quite used to comparison shopping for groceries, clothing or a new car, we aren’t really that good at comparing investment pricing.
That has to change. When you overpay for an investment, you automatically lose some of the implied return on that investment. If the investment loses money, you lose even more when you pay too much to own it.
What are the costs of investing? Here’s a simple cheat sheet to consider:
Commissions: This is the fee you probably think of first. If you buy or sell a stock, your brokerage will charge you for the transaction. Same with mutual funds, although probably more. Even if a fund is “commission free” it costs something to process, so the cost is built instead into annualized platform fees. Cost: Zero to $50 per transaction.
Mutual fund fees: A biggie, and poorly understood. Every mutual fund you own has some kind of internal cost. It can range from very low with money-market funds to very high, say, for an emerging market fund that covers 15 countries. Cost: Zero to 3% of assets or more, annually.
Sales loads: A “load” is basically an admission fee, charged by your broker for the work of making an investment available to you. These can be pretty stiff and often are taken out at the beginning of the investment, plus “12b-1” marketing fees which repeat annually, forever. Cost: Up to 8% of your assets.
Financial advisor fees: Advisors should be paid for their work recommending investments and helping with planning and portfolio construction. While many financial advisors work for an hourly fee, others will charge an annual fee based on your assets under management. Cost: Typically 1% but could be more.
Taxes: Finally, if you trade in a taxable account, you can expect to be taxed on your gains both short-term and long and on dividend income you realize during the year. This can vary according to the tax law and the amounts gained and lost, but it’s part of the total return equation. Cost: Zero to 20% of realized gains.
Lowering your cost of investing is paramount to building a retirement. You can’t compound money you don’t have because it left your account in the form of a fee.
How? Start by saving into tax-deferred and tax-free IRAs and workplace 401(k) plans. Then try to use only index funds with fees that are a small fraction of those charged by actively managed mutual funds. The ETF versions of index funds often trade commission-free.
Finally, you can avoid financial advisor costs by using low-cost online software to create and rebalance a retirement investing plan. The difference can be striking — and knock years off your expected retirement date.