Do you know how much you’re paying in fees for your investments? 1%? 2%? It may seem like such a small percentage that you ignore it. Even seemingly small percentages can have a big impact on your investment returns. Here is why you should pay attention to investment fund fees.
Mutual Fund Fees
What are Fees? Fees are the expenses you pay on your investments. There are all different types of investment account fees: loads for funds, payments to an investment advisor, etc. Here I’m primarily discussing the mutual fund fees and investment fund fees companies charge to manage the fund (though the ideas can be applied to any fee you pay to have your money invested).
How do you find out how much your investment fees are? Sometimes you may have to hunt through the prospectus to find the fund management fees for a certain investment. In some cases you may need to contact your employer if it’s for a fund in a 401k. But it’s worth knowing what you are paying for; you would never buy something at a store without knowing exactly what it would cost you.
Expense Ratios. The fund management fees are also included as part of the expense ratio for a fund. An expense ratio includes the management fees and the administrative cost.
Fees Calculated as a Percent on Investments not Earnings
The important thing to remember about these mutual fund fees is that it is a percentage of your investments – not a percentage on your earnings. What does that mean? If you have $10,000 invested in a mutual fund that has a 2% fee then you are paying $200. You pay this $200 regardless of how much you earn on this investment this year. You may earn $0 and you still have to pay the fund management fees.
This may not seem like much but what if you look at it as a percentage of your earnings? What if the fund had a great year and returned 10%? Then you would have made $1,000. Since you’re paying $200 in fees you are paying 20% of your earnings back in fees. (200/1000 = 20%).
What if you didn’t have such a great year and the fund only returned 4%? Then you would have made $400. Now that $200 in fees is half the money you earned.
What if the fund lost money? You’re still paying the fee so that just increases the amount your account goes down.
Of course you don’t write out a check – they simply take it from the account. This sometimes makes it feel like you are not paying these fees but you are just like any other bill.
The Difference Between 1% and 2%
Every fund charges some sort of fee so it can be tempting to think there isn’t much difference between 1% and 2%. If I told you I had 2 cars and one cost $10k and the other cost $20k you’d think there was a pretty big difference. In other words it can be easy to think of the difference between a 1% fee and a 2% fee as pretty small (it’s only 1%) but in reality that 2% fee is DOUBLE. With a 2% fee you are paying twice as much for the fund as a 1% fee. Hopefully it doesn’t seem so small anymore.
What Are You Paying For?
Some funds will say that the reason their fees are higher is that they produce higher than average returns. Of course no one can guarantee such results. The differences are even more apparent for things like index funds. Funds that follow the same index are essentially the same thing. Yet index fund fees vary between companies (sometimes by a lot). Compare your index fund fees to Vanguard fund fees to see the difference.
How High Are Your Fees?
You would never make a major purchase without shopping around and trying to get the best price. Use the same idea when looking at investment fees and it could save you a bundle.
Calculate the fees on your investments. How high are your investment fund fees? What are the expense ratios? For a reference point, Madison maintains a 0.114% expense ratio on her portfolio.
How much are you paying in mutual fund fees?