One of the most vital pieces of information that every investor should focus upon are the fees that they will pay for their investments. Our blog today is going to focus on exactly why these are so extremely important as well as looking at the different types of investments and what fees, high or low, that they carry.
Many investors, while focusing on other important aspects of investing such as the selection of the securities that they purchase for their asset allocation, overlook how important fees are and the impact that they can have on their returns. The fact is, the amount of fees that an investor will be forced to pay is one of the main determinants of how their investments will perform.
Below is a great example of why knowing the exact fees that you will be paying is so important. We’ve used $3,000.00 as our base amount that were going to assume is put into a retirement account, stay there over 30 years and earn an 8% annualized return. If you look at the simple chart you will find that the actual amount of return that a person receives after 30 years is greatly affected by the amount of fees that they pay.
- Fees of .50% produce a total return of $596,477.60
- Fees of .75% produce a total return of $572,454.51
- Fees of 1.00% produce a total return of $549,551.41
- Fees of 1.50% produce a total return of $506,807.81
- Fees of 2.00% produce a total return of $468,078.69
As you can clearly see, the difference between .50% and 2.00% in fees, only 1.50%, equates to a loss of $128,398.91 due to fees over a 30 year period!
In general most people look to withdraw from 3 to 5% out of their investment portfolio per year during their retirement. Using the numbers above as a guideline, the difference between the investor who paid .50% and fees and the investor who paid 2.00% in fees would mean that, on an annual basis, the former would make more than $5000 per year more than the latter. That equates to $420 per month less for the person who paid 2.00% in fees even though the initial amount of the investment was exactly the same and the amount of time that it was invested was also exactly the same.
Most experts agree that, while aiming for the lowest possible fees for the assets in your portfolio is a good idea, not all investments will always offer them. Certain types of investment products carry inherently higher fees while others inherently low. For example, “frontier” market mutual funds almost often have higher fees than US Large Cap stock funds. Corporate bonds purchased from the country of Brazil will, in most cases, carry higher fees than Treasury Bonds purchased from the United States. Futures contracts and standardized option contracts normally carry fees that are quite reasonable and relatively transparent while equity-linked notes are known to have higher fees as well as less transparency.
There are certainly many assets that have low fees. Index mutual funds as well as ETF’s are 2 that are very attractive to investors looking for long-term value. It is important to note that different providers of these assets will often have different fees and, since the product is essentially the same from provider to provider, the main cause of a better, or worse, return is likely to simply be their fees. Generally speaking, the more mainstream and asset class the lower fees that it will have and therefore it truly pays to find the lowest cost provider on any indexed product that you are considering purchasing.
When investing in mutual funds it is even more important to know exactly what fees you will be paying as many of them carry what they call “front end load” charges, sometimes to the tune of 5.5%. No matter how well your asset performs this initial charge is going to make it very difficult to actually outperform the market. Most financial pros will tell you that you should never buy a mutual fund that has significant up-front sales charges since oftentimes there are alternatives available without these charges. Researching any fund thoroughly is obviously a good idea and, if you do decide to purchase a fund with a front-end load fee, you’d do well to make sure that it’s expected future performance makes up for the initial loss.
As you can see, fees are one of the major determinants and how well your investments will perform and that, as an investor, one of your most important tasks is to find investments with low fees as well as minimize your fees over time in order to maximize the performance of any asset. While keeping fees low is definitely vital it need not be the dominant force in your decision-making process when it comes to investing. Tasks such as making the appropriate investments for your financial goals that are just as important as minimizing your fees.
If you have questions about how fees will affect your investments, what types of investments inherently have lower fees or investing questions in general, please let us know and will get back to you with advice and answers ASAP.