If you’ve ever been sailing, you know that current matters as much as wind. Even if the wind is moving you forward, if the water current is pushing you backward—you’re not moving as fast as you think. You might even be going backwards.
The same drag can happen when it comes to your investments. How? The fees that you have to pay a money manager or fund.
Assuming that you want your investments to make you the most fmoney possible (don’t we all?), it’s important to understand expenses and fees and the impact they have on your returns over time.
How Investment Fees Can Cost You Money
Let’s start with a real-life example. Say you’ve invested $10,000, and you’re averaging a decent, 6% annual return. Twenty years later, a manager charging 2% would have grown your $10,000 investment to about $21,400. But a manager charging only 0.25% would have grown it to about $30,500. Paying those fees cost you $9,100!
Fees aren’t usually presented that way, of course. Usually, they’re shown as an expense ratio—the percent of the amount being managed. This is also called Net Asset Value (NAV). This graph illustrates the impact of different expense ratios on the returns of funds that have the same 6% return (before fees), over 20 years.
Types of Investment Fees
So, what are all those fees, and how do they work? Here are some of the most common.
Management Fees
None of them work for free, but their fees vary widely.
Many people hire money managers to manage their money. None of them work for free, but their fees vary widely. Some charge as much as 2% and others far less. Generally speaking, the more money you have being managed, above a certain point, the lower your management fee will be as a percentage of the amount being managed. If you hire a money manager, their fees must be fully disclosed. Be sure you understand what you are being charged.
Mutual Fund Fees
Mutual funds (or packages of securities that people can invest in) can be a smart investment choice for almost anyone who wants a diversified investment portfolio, but they also have fees. And since fees are often hidden, understanding the true cost of an investment is important.
Mutual fund fees are typically:
Loads:
Some mutual funds have a sales charge, called a “load.” For example, if a fund had a $20 value and a 5% load, you’d pay $21 for the fund. If it had no load, you would pay only the $20 net asset value. To avoid these costs, look for no load mutual funds.
Commissions:
Exchange Traded Funds (ETFs) are mutual funds that trade like stocks. They don’t have a load, but you may have to pay commission to the brokerage firm through which you buy and sell it. Some firms also charge a commission on no load mutual funds. Commissions have come down significantly and several firms offer commission of less than $5 per trade. Some firms also offer commission free mutual funds and ETFs with no transaction costs.
Invest in the future–not fees
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Expenses:
Most funds have operating expenses, which include paying the fund manager(s). This is called an expense ratio—or the annual expenses divided by the fund’s value expressed as a percentage. It is the amount by which your annual return is reduced to the pay fund’s expenses.
Mutual funds can be actively or passively managed. Passively managed funds seek to track an index, like the S&P 500. Active funds have managers who try to perform better than an index. Actively managed funds generally have higher expense ratios than passive index funds, because they tend to do more trading and their managers often expect to be paid more. At SoFi, we want our members to keep their money. That means we focus on low expense investments and funds with low fees.
12b-1 Fees:
These are annual expenses for marketing the fund, usually paid to the firm or broker that sold it. They vary widely from fund to fund and are included in the expense ratio. Lots of funds don’t have them. Choose funds that don’t.
When you shop in a store, the prices are clearly marked. Financial services aren’t free, but their price tag is often hard to find. Some fees might be worth it, but make sure you understand what you’re paying for.
SoFi Wealth, LLC does not render tax or legal advice. Individual circumstances are unique and we recommend that you consult with a qualified tax advisor for your specific needs.
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