INVESTMENT FEES AND EXPENSES

In the world of investing, fees and expenses can significantly impact your bottom line. Whether you're a seasoned investor or just starting out, understanding the various fees associated with investing is crucial for maximizing your returns and achieving your financial goals. From management fees to transaction costs, each expense can eat into your profits if not carefully managed. In this article, we'll explore the different types of investment fees and expenses and their impact on your portfolio.

Types of Investment Fees and Expenses

Management Fees: These are fees charged by investment managers for managing your portfolio. Typically, they are calculated as a percentage of your assets under management (AUM). While management fees can vary widely depending on the type of investment and the manager's expertise, they usually range from 0.5% to 2% annually.

Distribution and Administrative Fees: These expenses cover administrative costs, marketing expenses, and other operational costs. These fees are often referred to as 12b-1 fees.

Sales Loads: Sales loads are commissions charged by mutual funds or brokerage firms when you buy or sell shares of a fund.

Transaction Costs: These are expenses incurred when buying or selling securities within your portfolio. They include brokerage commissions, bid-ask spreads, and other trading fees.

Advisor Fees: If you work with a financial advisor, they may charge a fee for their services, either as a percentage of your AUM or a flat fee.

Expense Ratios

Expense ratios represent the annual operating expenses of a fund expressed as a percentage of its total assets. Most investments bundle all of their fees and expenses into an expense ratio. This makes it easier to compare fees for different funds and investments. Lower expense ratios are generally preferred since they directly impact your investment returns over time. All of these fees and expenses are listed in each fund’s prospectus.

Examples

Let’s look at some examples of fees across some different investing scenarios. 

A – Using an investment advisor that buys low-cost index funds

B – Using an investment advisor that buys mutual funds

C – Using an investment advisor that buys individual stocks

D – Buying low-cost index funds yourself

Net Returns after Expenses

It is important to be aware of all of the fees and expenses, but the most important figure is the net return percentage after expenses. 

In the example above, the costs to use an advisor that buys mutual funds is the highest at 2.1%.  But if this advisor is able to generate much higher returns (3% higher for example), the investor would still end up ahead even after deducting the fees and expenses.

This is very rarely the case, however.  Higher fees don’t typically equate to better investment performance. In fact, the opposite is more often the case.  Portfolios with higher fees and more complex investment strategies typically have lower investment returns.

As we have shown in our other blog posts, low-cost index funds generate higher investment returns and have the lowest expense ratios. 

Financial advisors don’t typically purchase low-cost index funds for their clients because that approach doesn’t provide them with a justification to charge their 1% investment management fee.  This is why financial advisor either buy individual stocks for their clients or create complex portfolios comprised on many different assets (stocks, bonds, commodities, etc.).

Using historical performance data, let’s look at the net returns after expense for the four scenarios above. As you can see, the Do-It-Yourself investor can generate the best results if they know how to pick the best low-cost index funds.  The DIY investor can generate net investment returns that are almost 50% better than Advisors who buy mutual funds or individual stocks.

These differences in net returns after expenses are a big deal – potentially a difference of millions of dollars over 30 years.

Investing fees and expenses can significantly impact your investment returns over time. By understanding the different types of fees, their impact on your portfolio, and strategies for minimizing them, you can optimize your investment strategy and achieve your financial goals more effectively.

Be well,

Phil

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Disclaimers The Beyond Buy & Hold newsletter is published and provided for informational and entertainment purposes only. We are not advising, and will not advise you personally, concerning the nature, potential, value, or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. Beyond Buy & Hold recommends you consult a licensed or registered professional before making any investment decision.

Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.