How Fees Impact your Return

How Fees can Eat up Your Return

When you open a brokerage account, you are entering a contract for a service.  Generally, you are going to pay a transactional fee and/or and account fee to a custodian that will handle the documentation, record keeping, and  clearing process for your investments.  Your first transaction results in a “loss”, against your investment, equal to the fees paid to execute it.  The only way to recover the loss is to hold the investment and hope that it provides positive returns through appreciation and/or dividends.  Knowing what your investment will cost you, can help you make an informed decision about where, and how,  to invest.

When you invest your savings, using a mutual fund approach , you will pay a variety of fees.  Knowing what these fees are, and limiting them, will add to your overall return.

1.      Brokerage fees and trade commissions – Paid for the execution and record keeping associated with your account.  Vary widely, based on full service vs discount brokerage. ($4.95-$751).

a.      Account fees – Often there are annual fees for maintenance of an account ($10-$752,3,4).  

2.      Fund fees5,6,7  

a.      Load fees – These cover the commission paid to the agent/firm that sells the fund.  They can be paid as “Front-End”, “Back-End”, or “Level Load” (1-8.5%).

b.      Transaction costs – Associated with the trading of the internal fund assets.  These costs will be less in funds with lower portfolio turnover.  High turnover can result in a trading drag of 0.8%-3% on a fund’s performance.  These fees are taken out of fund assets and are not reported separately (they are reflected in the funds return).

c.      Mutual Fund purchase fee “Shareholder fees / Redemption fees (Limited to 2%) / Exchange Fees” – some funds charge this fee whenever there is an exchange, purchase, or sale of fund shares ( costs vary).

d.      Account fees – Frequently charged for low value accounts (costs vary).

e.      Operating  Expense fees – Management/maintenance/advising fee.  This is the ongoing fee that is reported for the fund.  This annual fee can range from very little (0.05%-passively managed) to greater than 1.5% (actively managed).

f.       12b1 fees – Fees paid to the fund to cover marketing and selling of the fund, or to provide ongoing compensation of brokers who sell the funds (< 0.25% for services < 0.75% for commissions). 

3.      Advisory Firm Fees – The parent firm charges a fee. This is for the back office support and legacy costs.  If  you are sold a fund that carries a load, this fee usually covers the firm and the agent.

4.      Agent Fees – This fee is compensation for the individual you work directly with. 

a.      When an agent sells investment products, this usually comes from the commission (load) associated with the fund.

b.      When it is a fee-only firm the fee is either a set amount, or a percent of the Assets Under Management.

If it seems like there are a lot of fees, it is because there are.

These fees can make a significant impact to your savings goals.  For example: you make a one time investment of $100k, at an average return of 7%, over 20 years with two separate advisors.  Under advisor A, your annual total fees paid under Advisor A are 3%.  This results in an account balance, at the end of 20 years, of:

Advisor A = $222,258

Under advisor B, your annual total fees paid are 1.5%.  This results in an account balance, at the end of 20 years, of:

Advisor B = $299,663

This difference can be understood through the impact of fees.  Under Advisor A, when your account is up 7%, you only realize 4%.  When your account is down -2%, you realize -5% loss.  This is because fees are withheld from your account, usually through the liquidation of securities.

When working with a financial advisor, always identify the fees you will pay, and to whom they will be paid.  At SFM Financial Advisors, we focus on no-load funds and ETFs.  We work to manage the fees and the tax considerations so that you can keep more of your money working for you.  

A useful tool for comparing fund fees only, can be found at the FINRA web site,  Fund Analyzer .

Be informed and make better decisions.