Every fee you pay to your financial advisor, to an expense ratio, a bank, or a transaction fee is money that isn’t compounding and making you more money.
Investment fees often seem small, but can add up to be a large part of your portfolio over time. Many investment fees can be avoided – either by choosing different funds, switching to a lower-cost brokerage or investing for yourself.
Side note: If you want to learn to invest for yourself, check out the Minafi Investor Bootcamp. This 3-month series of courses go over how to invest from scratch with an eye for reducing fees.
How Much Is Lost To Fees Over Time?
Let’s look at two sample scenarios:
In the first scenario we have Casual Investor. Casual Investor works with a financial advisor that charges a 1% fee. For this fee, the advisor manages their portfolio and decides which funds to invest in. One fund they invest in is $RYSOX, an S&P 500 fund that tracks the largest 500 companies in the United States. This $RYSOX fund also has a 1.67% expense ratio (!).
In the second scenario we have Informed Investor. Informed Investor opened a Vanguard account and put all their money into $VFIAX, Vanguard 500 Index Fund Admiral Shares. Since they’re managing their own investments they don’t pay a 1% financial advisor fee. $VFIAX does have an expense ratio as well, but it’s much lower – only 0.04%.
In total, Casual Investor is paying 2.67% a year in fees, while Informed Investor is only paying 0.04%. You read that right – Casual Investor is paying 66x more in fees to be invested in the same 500 companies that make up the S&P 500.
This is the situation that so many investors find themselves in. If you’re new to investing, 2.67% may not sound like a lot. It’s small, so many investors don’t look deeper into it. Investors that do look deeper into the impact of these fees are in for a shocking surprise.
Take a look at how these fees stack up over time assuming constant market growth and the same performance:
These lines are diverging by 2.63% a year – the difference between the fees charged. The trick is that every dollar spent on these fees doesn’t compound. The longer your time horizon, the larger impact these fees will have on your portfolio!
After only 28 years, the amount in your account would be doubled if you invested this same amount yourself. That’s huge! That could be the difference if you can retire early or if you need to work for another decade.
Investment Fees to Watch For
Let’s break these fees down one by one and see how much each of them “cost” us over time. The four types of fees that are most prevalent include:
Financial Advisor Fees – These range from 0.25% of assets of under management up to over 1%. Even Roboadvisors like Wealthfront and Betterment charge a fee for assets under management. This fee is paid out by you directly to the advisor.
Lowest possible advisor fee: $0 if you manage your own portfolio. 0.25% with a Roboadvisor. 0.5% to 1% with an advisor.
Expense Ratio Fees – Most mutual funds and ETFs charge what’s called an “expense ratio fee”. This can range anywhere from 0% to over 2%. Vanguard has some of the lowest fees in the industry, and charges between 0.03% and 0.20% for most funds. As an investor you never see this fee withdrawn from your account as you do with financial advisor fees. Instead, the expense ratio is built into the price of the fund. In other words, if two funds were identical except for this fee, the one with the higher fee would have the lower performance.
Lowest possible expense ratio fee: Fidelity has a few funds with zero fees. All funds at Vanguard have a very low fee. Most other brokerages offer a few funds with a very low fee. I try to pay under 0.05% for a US fund, 0.10% for bond funds and 0.20% for international funds. The lower the better!
Front-Load/Back Load Fees: Front-load and back-load fees are one-time expenses when you buy a fund (front-load) or when you sell a fund (back-load). These are notoriously awful and should be avoided at all costs. These are shown as a percentage, for example “front load of 5.75%”. That means that if you invested $10,000 into that fund, you’d pay a $575 fee first, then the rest would be invested ($9,425 in total).
One of the largest mutual funds in the world is $ABALX, American Funds American Balanced A. With a name like “American Funds”, you’d think it’s an amazing, patriotic investment. In reality though, this fund charges a 5.75% front-load fee! That money goes straight in the pocket of your financial advisor for bringing you on as a client.
Lowest possible front-load/back-load fee: $0. If you see a front-load or a back-load fee you should run away. Fast. There are better funds out there with no front-load or back-load.
Fund Comparison: $VTSAX vs $ABALX
Let’s look at a real-world example using two of the most popular mutual funds in the world:
- $VTSAX – Vanguard Total Stock Market Index Fund Admiral Shares
- $ABALX – American Funds American Balanced A
You can tell both of these are mutual funds because they both end in an X.
Side note: Mutual funds and ETFs (Exchange Traded Funds) are extremely similar. I prefer mutual funds for long-term investing since they allow for automatic investing and buying fractional shares.
Besides their popularity, these funds don’t have too much in common. $VTSAX invests in over 3,000 different US companies weighted by how large they are. $ABALX splits its investment between about 50% US Stocks, 10% International stocks, 30% bonds, and 10% cash.
In other words, these are very different investments. You could recreate this kind of a portfolio by splitting your investment between $VTSAX, $VBTLX and $VTIAX and have a more diversified portfolio 1/10th the cost.
For the sake of comparing fees, let’s see what would happen if both of these funds grew at the same constant pace year over year:
The last line says it all. Compared to a baseline with no fees, you’d end up paying 49% of your total potential growth to fees with $ABALX! With $VTSAX you’d still pay some fees, but they’d only end up totaling about 1.38% of your portfolio.
You might be wondering: could I do this myself and not pay the 1.38% fee? That’s unlikely. This Vanguard fund invests in over 3,500 companies and it making changes to the portfolio every day to keep it balanced. The amount of work that goes into that is completely unrealistic to do manually.
The only lower-cost option I’m aware of is the rise of 0% fee funds like $FNILX (Fidelity® ZERO Large Cap Index Fund). More companies are offering these “loss-leaders” to attract investors with the hope that they also invest in another Fidelity fund with a higher fee.
Be aware that just because a company has a low-fee fund it doesn’t mean all of their funds are low-fee (unless they’re Vanguard).
Investment Fees Calculator
Want to calculate fees for yourself based on two funds with different fee structures? Tweak the below settings compare the growth of two funds over time.
How To Lower Your Investment Fees
Learning about investment fees and their impact on my own portfolio was a major turning point. After I realized how many potential gains I was giving up, I immediately began learning everything I could about investing.
For me that meant reading The Bogleheads Guide to Investing – which I still recommend as a great way to learn how to invest. This funny-named book shows how to invest for yourself in the stock market for yourself with an eye for diversification, fees and lower taxes.
Another great place to get started with J.L. Collins A Simple Path to Wealth, or his free stock series of blog posts. These go over the same topics as the book if you’re willing to click around.
Another free resource is my own course here on Minafi: The Minimal Investor. This free 10-article course goes over everything you need to know to get started investing on your own.
Take a Step To Lower Fees
I encourage you to understand how fees are impacting your portfolio. Just knowing how investment fees work is a huge step towards avoiding them!
If you’re working with an advisor today, consider working with them to lower your fees, navigate away from future fees, and maybe even decide it’s time to ditch your financial advisor.
2 CommentsWhy not add to the conversation below? Your voice is welcome!
May 25, 2020
Very nice calculator. For years I was in actively managed mutual funds. There were no upfront loads and I tried to pick funds where the expense ratio was below the category average. I thought I was being good by doing that. In 2017-2018 I finally switched most of our investments to index funds and reduced our average costs dramatically. I made it a point to not look back and calculate how much we sacrificed in those high fees. Too painful!
May 28, 2020
As far as active loads go, it could be a lot worse! At least you’re set now to coast long-term with index funds. I look at my time investing with an advisor as paying for an education on what not to do.