No one likes paying fees. Especially if you feel they are hidden or unnecessary. Think about the last time you stayed at a nice resort. More than likely there was a $30-50 daily resort fee tacked on to your already expensive hotel bill. How about changing your airline ticket? “Hey, thanks for giving us more money by switching to a higher priced flight, now here’s a $200 fee.” Pet travel fees? Sure bring your screaming 3 month old on the plane, but if you want little Fido to sit in her carrying case at your feet, it’s going to cost you $125. Come to think of it, I did once have someone sit behind me on a plane with their cat that meowed for the entire 3 hour flight (who flies with a cat?). Perhaps pet travel fees aren’t all that bad.
When it comes to investments, many people don’t take this same hard stance against fees. The average mutual fund charges a fee of 1.3%-1.5%. That means the fund will have to beat the market by up to 1.5% just to break even. This is where fund managers struggle. In recent years, it was found that 90% of active fund managers beat the market. The only problem is that their shareholders don’t. Countless studies have shown that after taking into consideration fees and costs, most fund managers fail to beat their benchmark. So why then, do investors still pay these fees?
What Exactly am I Paying For?
Many investors simply aren’t aware of these fees. If you are aware of these fees, you should at least know what you’re paying for. There are two types of mutual fund fees you may find yourself paying. First, there are ongoing yearly fees to keep you invested in the fund. Second, are the transaction fees paid when you buy or sell shares in a fund.
The ongoing yearly fees are expressed in the form of an expense ratio. This is the fee I mentioned above that can average up to 1.5%. This covers the cost of hiring the fund manager and is the most significant portion of the overall fee. While it may not sound like much, a small mutual fund has, on average, $250 million in assets. That means a small mutual fund manager earning 1% would be bringing in $2.5 million a year. That’s no small amount for someone who likely isn’t beating the market for his or her shareholders.
Other costs included in the ongoing expense ratio include administrative costs, such as record keeping and customer service. On top of this, there could be a 12B-1 fee included in the overall expense ratio. This fee goes towards paying the advertising and promoting costs of the fund. Yep! If you’re investing in a fund with a 12B-1 fee, you’re directly paying for the cost of the fund to run ads and sell itself!
The second fee you could find yourself paying is a transaction fee. These are commonly known throughout the industry as loads. What do you need to know about loads? Simple. Don’t buy a fund with loads. Still curious about loads? There are two types of loads you’ll find. Front-end loads and back-end loads.
Front-end loads are fees you pay when purchasing a fund. Say you invest $10,000 into a fund with a front-end load of 3%. That means you immediately pay the fund $300, and only have $9,700 to invest. That may not sound like much, but consider the impact over time. Let’s say you begin investing $10,000 a year at the age of 22 into this front-end load fund, and you earn an average annual return of 10%. Because you are only getting to invest $9,700 after the fee, you would end up with $120,000 less by the time you are 60.
Back-end loads charge a fee if you sell the fund before a certain time frame. For example, a fund may have a back-end load of 6% if you sell in the first year, 5% if you sell in the second year, and so on.
With the number of investment options available today, there is simply no reason to invest in a mutual fund with a load. There is no evidence that shows load funds provide superior performance over no-load funds. In the end, you’re just throwing more money away through unnecessary fees.
There are several good sources available to identify fees within your portfolio. The Personal Capital Retirement Fee Analyzer shows the average annual expense ratio on my retirement accounts is 0.67%. This is above the benchmark of 0.50% and is costing me 2 years of retirement. Not good.
The next step is to analyze my portfolio to see which funds are costing me the most in fees. Using the Investment Checkup tool in Personal Capital to dig into my holdings, I found the biggest culprit to be American Funds The New Economy Fund Class C (ANFCX). The expense ratio on this fund is a fat 1.59%. It also makes up just under 20% of my pre-tax retirement accounts. These are primarily rollover IRA accounts from my wife’s and my previous employer 401k accounts. An advisor that my dad uses from time to time set up the rollovers into IRA accounts as well as the investments. Overall the investments have performed very well, but I think some tweaks can be made to reduce fees and increase returns in the process.
To go any further with Personal Capital, you will need to sign up for their paid service. This involves an advisor being assigned to you for a set percentage of your total investable assets. The advisor will then work with you to optimize your portfolio to meet your needs. I don’t like the idea of paying an ongoing fee to an advisor as I wrote about in Do You Need a Financial Advisor. Especially given that he or she will just set me up in low-cost ETFs anyways. This I can do on my own.
Finding The Best Low-Cost Alternative
Another fee identification service I recently came across is FeeX. FeeX works similar to Personal Capital in that it identifies fees once you link all of your investment accounts. But there are two key differences. First, FeeX will identify other fees than just the expense ratio, such as plan fees in your 401k account, advisory fees and transaction fees and loads. This gives you a complete picture of the total fees you’re actually paying. The key difference, though, is that FeeX will recommend similar low-cost alternatives. Best of all, these services are all provided free!
The alternatives provided by FeeX to replace ANFCX are shown below. There were nine alternative funds provided. I sorted these by best long-term returns to see how the funds performed over the past 5 and 10 year periods. Investing in a fund with a proven track record provides me with a lot more comfort than a fund that has just performed well over the last couple of years.
The Fidelity Nasdaq Composite Fund is a 5 star rated fund on Morningstar. FeeX shows it is 85% similar to ANFCX. It also has much better short-term, and more importantly long-term returns. Best of all, the annual fee is a paltry 0.21%. Much lower than the 1.59% charged by ANFCX. Apparently, you don’t always get what you pay for. FeeX calculates this move alone will save me north of $25,000 over the next 25 years.
Keep More of Your Money
This process has been long overdue for me. It’s a very eye-opening process to see some of the high fees charged by mutual funds. Using a tool like FeeX will show you there is almost always a better alternative to high-cost mutual funds. You may not always have a choice. Some 401k plans only offer high-cost mutual funds. But there are many people paying high fees for no good reason. I was one of them! Because my rollover IRA accounts had provided nice returns (11.8% since mid-2009), scrutinizing the investments in them was not high on my to do list. We’ve probably all been part of a company or sports team when times are good. What happens? We stop focusing on ways to improve. Everything is going great! Who cares? No matter how well things are going, there’s always something that can be improved.
You should also think twice about signing on with an advisor when he or she tells you they can optimize your portfolio. In my experience, the ongoing cost isn’t worth it, and there are plenty of tools available for you to do it on your own. Thank them for pointing out that you’re paying too much in fees, and use a program like FeeX to find better alternatives. You can also use the many tools in Personal Capital to ensure you have the proper asset allocation to meet your goals. It’s a lot cheaper than paying someone else to use a similar more expensive program. And as we saw above, you don’t always get what you pay for.
Readers, what is the average expense ratio for your portfolio? Share your thoughts about fees and recommendations for keeping them low. What mutual funds do you invest in that you believe are worth the additional cost?