Before you invest, take the time to understand all the investment fees associated with your investment.
Any investment advisor worth working with should be willing to explain, in plain English, all the various types of investment fees that you will pay. If you don't work with an advisor, you'll still pay fees. You'll have to go through the prospectus and financial institution websites and documents to see what those fees are.
When inquiring about investment fees, if someone says, “My company pays me,” get more details. You have a right to know what you are paying, and how someone is being compensated for recommending an investment to you.
Here are the six types of investment fees to ask about.
1. Expense Ratio or Internal Expenses
- A fund with an expense ratio of .90% means that for every $1,000 invested, approximately $9 per year will go toward operating expenses.
- A fund with an expense ratio of 1.60% means that for every $1,000 invested, approximately $16 per year will go toward operating expenses.
The expense ratio is not deducted from your account, rather the investment return you receive is already net of the fees.
Example: Think about a mutual fund like a big batch of cookie dough; operating expenses get pinched out of the dough each year. The remaining dough is divided into cookies or shares. The value of each share is slightly less, because the fees were already taken out.
You can't compare expenses in all types of funds equally. Some types of funds, like international funds, or small cap funds, will have higher expenses than a large cap fund or bond fund. It is best to look at expenses in terms of your entire portfolio of mutual funds. You can build a great portfolio of index funds and pay no more than .50% a year in mutual fund operating expenses.
2. Investment Management Fees or Investment Advisory Fees
Investment management fees are charged as a percentage of the total assets managed.
Example: An investment advisor who charges 1% means that for every $100,000 invested, you will pay $1,000 per year in advisory fees. This fee is most commonly debited from your account each quarter; in this example, it would be $250 per quarter.
Many advisors or brokerage firms charge fees much higher than 1% a year. In some cases, they are also using high-fee mutual funds in which case you could be paying total fees of 2% or more. It is typical for smaller accounts to pay higher fees (as much as 1.75%) but if you have a larger portfolio size ($1,000,000 or more) and are paying advisory fees in excess of 1% then you better be getting additional services included in addition to investment management. Additional services might include comprehensive financial planning, tax planning, estate planning, budgeting assistance, etc.
3. Transaction Fee
Many brokerage accounts charge a transaction fee each time an order to buy or sell a mutual fund or stock is placed. These fees can range from $9.95 per trade to over $50 per trade. If you are investing small amounts of money, these fees add up quickly.
Example: A $50 transaction fee on a $5,000 investment is 1%. A $50 transaction on $50,000 is only .10%, which is minimal.
4. Front-End Load
In addition to the ongoing operating expenses, mutual funds build in commission charges. These commissions vary not only in amounts, but it the way they are applied. There are several different share classes of mutual funds. The most common mutual types are Class A and Class B.
A Class A share mutual fund charges a front-end load, or commission.
Example: A fund that has a front-end load of 5% works like this: You buy shares at $10.00 per share, but the very next day your shares are only worth $9.50, because 50 cents per share was charged as a front-end load.
5. Back-End Load or Surrender Charge
In addition to the ongoing operating expenses, Class B share mutual funds charge a back-end load or surrender charge. A back-end load is charged at the time you sell your fund. This fee usually decreases for each successive year you own the fund.
Example: The fund may charge you a 5% back-end load if you sell it in year one, a 4% fee if sold in year two, a 3% fee if sold in year three, and and less as time goes on on.
Variable annuities and index annuities often have hefty surrender charges. This is because these products often pay large commissions up front to the folks selling them. If you cash out of the product early the insurance company has to have a way to get back the commissions they already paid. If you own the product long enough the insurance company recoups its marketing costs over time. Thus the surrender fee decreases over time.
6. Annual Account Fee or Custodian Fee
Brokerage accounts and mutual fund accounts may charge an annual account fee, which can range from $25 to $90 per year. In the case of retirement accounts such as IRA’s, there is usually an annual custodian fee, which covers the IRS reporting that is required on these types of accounts. This fee typically ranges from $15 to $80 per year. Many firms will also charge an account closing fee if you terminate the account. Closing fees may range from $25 to $150 per account. Most of the time, if you are working with a financial advisor who charges a percentage of assets, these annual account fees are waived.
Frequently Asked Questions (FAQs)
Which type of investment typically charges the lowest fees?
You can avoid fees altogether by choosing stocks yourself. However, stock picking is not as easy as using an ETF or mutual fund that benefits from diversification. Out of the investments that do charge fees, broad index ETFs and mutual funds usually charge the lowest expense fees. The less a fund manager has to do, the less you'll pay in fees, so sticking with passive funds will keep your fees low.
What investment fees are tax-deductible on returns?
Investment fees and trading commissions used to be tax-deductible on your annual returns, but that's no longer the case. Investment-related tax deductions were among the miscellaneous itemized deductions eliminated by the Tax Cuts and Jobs Act in 2018. Those provisions are set to expire at the end of 2025, so those tax deductions could theoretically return in 2026.