How to Keep Your Investment Fees Low – And Why It’s So Important to Your Bottom Line

When it comes to investing, most folks focus mainly on their portfolio’s overall rate of return. Investment fees fall lower on the priority list.

But let’s say you pay an average of 2% in investing fees on a $100,000 portfolio. Over 30 years, that will cost you $60,000, not to mention how much you’ll lose if that portfolio increases in value.

That’s why it’s critical to keep your investment fees low. Investment fees reduce your returns.

Just by reducing — or eliminating — investment fees, you can instantly improve the performance of your portfolio.

So how do you lower your investment fees?

Know What Investment Fees You’re Paying

Before you can lower your investment fees, you must know what they are.

Here are the main offenders.

Commissions & Trading Fees

These are fees charged by your broker for the buying and selling of various securities and funds. Most brokers base commissions on a flat fee — say, $7.95 per trade.

That may not seem like much if your trades are high-dollar amounts, but it can take a big chunk out of smaller transactions. Over many trades, those fees can add up.

You can reduce these fees by shopping for a lower-cost discount brokerage or by trading less often.

Mutual Fund Fees – Front-End & Back-End Loads

These are sales fees charged by mutual funds themselves. In general, they range from 1% to 3% of the fund amount, but they can go much higher. Some loads exceed 5% of the amount invested and can go as high as 8.5%.

Some funds charge loads upfront (front-end loads) and some upon the sale of your position (back-end loads or redemption fees). Still others charge both.

Many back-end loads are called contingent deferred sales charges. These fees shrink each year until they disappear. For example, you might pay a 5% redemption fee the first year, 4% the second, and so on, until the redemption fee disappears.

Front-end and back-end loads may matter less if you buy and hold funds for many years, but they can become significant if you trade frequently.

Expense Ratios

The simplest definition of an expense ratio (ER) is the cost to own the fund. Expense ratios are annual fees charged by all mutual funds, index funds and exchange-traded funds (ETFs). The ER is represented as a percentage of your investment. The lower the expense ratio, the more money you keep in your portfolio and the more money works for you.

12(b)-1 Fees

We can think of these as stealth expenses, since most investors aren’t aware of them unless they’ve read their mutual fund prospectus very carefully.

That’s mostly because 12(b)-1 fees usually aren’t a direct charge to the investor, but are paid through a reduction in your principal balance each year.

These fees can range between 0.25% and 1% of the fund assets and cover expenses such as fund advertising and marketing. Obviously, you’ll want to favor funds that are on the lower end of that expense range whenever possible.

Margin Interest

It’s not technically a fee, but margin interest can still reduce your investment performance.

A margin account is a brokerage account that lets you borrow money from a broker to purchase stocks or other securities. Because you can borrow up to 50% of a trade’s value, margin lets you double the rate of return on your actual principal.

For example, let’s say you invest $5,000 in a stock that goes up by 10%. You’ll profit $500.

However, what if you borrow another $5,000 to invest a total of $10,000 in that stock? When the trade’s value increases to $11,000, after you pay back the $5,000 and subtract your initial $5,000 investment, you’ll have made $1,000.

Unfortunately, there’s no such thing as a free lunch. You’ll need to pay interest on your margin loan.

With margin rates currently running as high as 10%, this can substantially reduce your profits and magnify any losses you may experience.

Investment Manager Fees

You won’t pay these if you’re a DIY investor. But you may pay these fees if you use a financial advisor to manage your investments.

There are many ways investment managers get paid, including:

• Commissions – A kickback from the mutual fund company, usually a percentage of the front-end load
• Assets Under Management – A percentage of the assets they manage, typically 0.5% – 1% of managed assets
• Fee-only – A flat rate, often based on an hourly rate, or for creating an investment plan or annual review
• Some combination of the above.

It’s essential to understand how your investment advisor is paid so you can determine whether there’s a conflict of interest in their advice and recommendations. Not all investment advisors have a fiduciary duty to act in your best interest, and their recommendations may serve their interests more than yours.

If you decide to pay an investment advisor to manage your investments, watch for frequent trading, high loads, high expense ratios, and other portfolio activity that can trigger large expenses on your behalf.

You can also consider a service like Vanguard Personal Advisor Services (PAS), which pairs you with a personal advisor for a low management fee. You get the best of both worlds: low-cost access to financial advisory services.

How Much Do Investing Fees Impact Your Investments?

To know how much you’re actually paying in investing fees each year, total what you pay for each of the fees above, plus any other costs you’re charged, such as taxes, advisor management fees, etc. The impact can have an enormous drag on your anticipated returns.

Cumulative Impact of Fees Over Time

The following chart, courtesy of Vanguard, illustrates the impact fees can have on your investment returns:

Time Horizon (Years)	0.10% (Annual Fees)	0.25%	0.50%	1.00%	2.00%	3.00%
3 years	–0.3%	–0.7%	–1.5%	–2.9%	–5.8%	–8.5%
5 years	–0.5%	–1.2%	–2.5%	–4.9%	–9.4%	–13.7%
10 years	–1.0%	–2.5%	–4.9%	–9.5%	–18.0%	–25.6%
20 years	–2.0%	–4.9%	–9.5%	–18.0%	–32.7%	–44.6%
30 years	–3.0%	–7.2%	–13.9%	–25.8%	–44.8%	–58.8%
40 years	–3.9%	–9.5%	–18.1%	–32.8%	–54.7%	–69.3%

The Impact of Paying 1% or More in Investment Fees

On the surface, paying “only” 1% in investment fees doesn’t seem like much. But according to Vanguard, it can reduce your returns by 25.8% over 30 years. Let’s pause for a moment and let that sink in.

A 1% expense ratio on your investment fund can cost you 25% of your returns over 30 years.

The more you pay in expenses, the less money you keep in your portfolio. Less money in your portfolio means compound interest won’t work as much in your favor.

Why stop at 1%? It’s easy to rack up investment fees that add up to more than that.

Here are some hypothetical fees you could pay on a mutual fund. None of these are out of the ordinary:

• Commissions and Trading Fees – Variable; usually a one-time fee, per trade
• Mutual Fund Load – 3-5%; usually a one-time fee, per trade
• Expense Ratio & 12(b)-1 fees – 1% (ongoing expense)
• Investment Advisor / Management Fees – 1% (ongoing expense)

Reducing your ongoing fees has the greatest impact.

You should never ignore one-time fees, since commissions and loads can add up quickly, especially if you or your advisor trades frequently.

But ongoing expenses have the biggest impact. The Vanguard study and chart referenced above pertain only to ongoing expenses. It doesn’t account for commissions and loads.

As the hypothetical expenses show, it’s easy to reach 2% in ongoing expenses with just expense ratios and advisor fees. Paying 2% in ongoing expenses will reduce your earnings by 44.8% over 30 years. That’s almost half your total returns, all for giving up “only” 2%!

How to Reduce Your Fees and Keep More Money in Your Investment Portfolio

Only once you know how much you’re paying in fees- and it can be shocking- can you start reducing those expenses.

You can use strategies to make that happen.

In general, favor low-cost index funds or no-load funds, reduce the frequency and types of trades, use low-cost or discount brokerages, and diversify your investments.

Finally, if you use an investment advisor, understand how they’re compensated and, if possible, reduce your exposure to ongoing management fees.

The following tips can help you implement these strategies.

Favor No-Load Funds

Since mutual fund loads can take up to 3% off your investment, favor no-load funds. Fortunately, more no-load funds are available now than ever, thanks to greater investor awareness driven by the internet.

In general, exchange-traded funds (ETFs) don’t charge a load. This is largely because ETFs are more often index funds. Those funds typically don’t have loads because the funds themselves require very little management. They involve very little trading because they’re established to replicate the composition and performance of the underlying index.

Mutual funds are much more likely to involve loads. This is because mutual funds are much more likely to be actively managed funds. That means management tries to outperform the general market, a strategy that involves more hands-on portfolio management and much more trading.

It’s not unusual for portfolio turnover to exceed 100% per year in an actively managed mutual fund. But all of that adds to the cost.

The downside of actively managed mutual funds – and why you should favor no-load index funds – is that the vast majority of actively managed funds actually underperform the market indexes. In fact, a ra 2016 Financial Times analysis found that 86% of active equity funds underperformed the market, a trend that’s remained broadly consistent in subsequent years based on S&P’s annual SPIVA scorecards.

That should make switching to no-load index funds very easy!

Invest Through a Lower-Cost Discount Brokerage Firm

Exactly how important this step is depends on how actively you trade your portfolio. If you make more than a few trades per month, these seemingly small commissions can add up and hurt your investment performance over the long term.

Commission-free trading has become the industry standard at most major brokerages, but a few legacy or specialty firms still charge per-trade fees, sometimes $5-$10 per trade.

For example, several low-cost brokerages, such as Ally Invest, Firstrade, and others, don’t charge commissions on stock trades and some mutual funds.

Some trading platforms — such as Robinhood — don’t charge any commissions or fees on stock or options trades. While these sites tend to offer more limited investing options, commission-free trades are certainly appealing.

If you currently make, say, 20 trades per month, at $9.95 per trade, you’re paying roughly $200 per month in commissions. But by switching to a lower-cost discount brokerage firm, you can cut that number in half and save yourself $100 per month.

That’s $1,200 per year, which will improve the rate of return on a $100,000 portfolio by 1.2% per year.

Keep Trading to a Minimum

If you’re an active trader, seriously consider whether the added activity is actually improving your rate of return compared to simply investing in an index fund.

For example, say an index fund returned 10% last year. At the same time, your custom, actively traded stock portfolio returned 17%  but cost you 8% in investing fees. Your profit – 9% – is lower than what you’d get with the fund.

Very few people have the time, talent, resources or inclination to outperform market indexes on a consistent basis. But you can spend a lot of money on commissions and other fees trying to do just that.

Unless your trading activity consistently outperforms market indexes, after deducting additional investment expenses, you’ll almost always be better off avoiding trading as much as possible.

Diversify – But Don’t Take It Too Far

Most investors understand the importance of diversification. But at some point, diversification can become counterproductive. You don’t need to own 80-100 stocks. That’s what mutual funds and ETFs are for.

At the same time, you don’t need to hold 20, 30 or 40 funds in your portfolio, either. You can achieve excellent diversification by investing in just a few funds.

In fact, this is exactly what “robo advisors” do.

For example, Betterment uses just six stock ETFs and six bond ETFs to cover the entire market. The stock funds cover the total U.S. stock market, large-, mid-, and small-cap stocks, international stocks and emerging markets stocks, giving you exposure to virtually the entire global stock market with just six plays.

Wealthfront uses a similar allocation but also includes funds that invest in real estate and natural resources.

By limiting your portfolio diversification to ETFs, you’ll avoid the investment fees that come with a highly diversified portfolio. And your investment performance will likely be at least as good with fewer allocations.

You owe it to yourself to drop your investment fees down as low as possible. It could mean the difference between, say, a 6% annual rate of return and an 8% rate of return.

Put that in your investing calculator and see what it could do to your portfolio over the next couple of decades.