Understanding Investment Fees: The Hidden Costs That Eat Your Returns

A 1% fee might sound small, but over decades, it can cost you a large share of your potential savings. Investment fees are one of the few factors investors can control, unlike market returns. Understanding the fees you pay and choosing lower-cost options is one of the easiest ways to improve your long-term investment results.

Why fees matter so much

Fees come out of your investments every year, regardless of whether your investments go up or down. Because of compounding, you lose not just the fee itself but also all the growth that money could have earned over time.

Over long periods, the difference between low-cost and high-cost investments can be dramatic. The SEC has published examples showing how even a fraction of a percentage point in fees can make a noticeable difference in an investment’s value over 20 years, and the effect grows larger over longer periods.

As your portfolio grows, the dollar amount of fees grows too. On a $500,000 portfolio, a 1% annual fee equals $5,000 a year, every year.

Common types of investment fees

Expense ratios are annual fees charged by mutual funds and exchange-traded funds to cover operating costs, such as management, administration and record-keeping. They’re expressed as a percentage of your investment and deducted from the fund’s assets, so you don’t see a separate charge, but they reduce your returns. Index funds typically have much lower expense ratios than actively managed funds.

Advisory fees are what a financial adviser charges for managing your investments or providing advice. Many advisers charge a percentage of the assets they manage, often around 1% annually, though rates vary. Others charge flat fees, hourly rates or retainers.

Sales loads are commissions charged by some mutual funds. A front-end load is charged when you buy shares, reducing the amount invested. A back-end load, or deferred sales charge, is charged when you sell, often declining the longer you hold the fund. No-load funds don’t charge these commissions.

12b-1 fees are marketing and distribution fees included in some funds’ expense ratios, used to pay for advertising and compensating brokers.

Account fees may include maintenance fees, inactivity fees, transfer fees and fees for paper statements that some brokers charge.

Trading costs include commissions, which many brokers have eliminated for stocks and ETFs, and bid-ask spreads, the difference between the price to buy and sell a security.

In workplace retirement plans, you may also pay administrative fees for running the plan, in addition to the expense ratios of the funds you choose.

Do higher fees mean better performance?

Not necessarily. Many studies have found that most actively managed funds underperform comparable low-cost index funds over long periods after fees are taken into account. Higher fees create a higher hurdle that a fund must overcome just to match the market. While some active managers do outperform, it’s difficult to identify in advance which ones will do so consistently.

This is one reason low-cost index investing has become so popular.

How to keep fees low

Consider low-cost index funds and ETFs, which track broad market indexes and typically charge very low expense ratios.

Compare expense ratios before choosing funds. When comparing similar funds, such as two S&P 500 index funds, the one with the lower expense ratio will generally deliver better net returns over time.

Ask advisers exactly how they’re paid and what you’ll pay in total, including advisory fees, fund expenses and any commissions. Understanding total costs helps you evaluate whether the advice and services are worth the price. Fee-only advisers, who are paid only by clients rather than through commissions, may have fewer conflicts of interest.

Avoid funds with sales loads when comparable no-load alternatives are available.

Review your workplace retirement plan’s investment options and choose lower-cost funds when possible. Your plan’s fee disclosure documents show the costs of each option.

Watch for account fees and consider brokers that don’t charge maintenance or inactivity fees.

Where to find fee information

Look in a fund’s prospectus and fact sheet, which list its expense ratio, sales loads and other fees. Your account statements and your broker’s website also show fees. Workplace retirement plans must provide fee disclosures to participants.

FINRA’s Fund Analyzer tool can help compare the costs of mutual funds and ETFs and show how fees affect the value of your investment over time. The SEC’s Investor.gov website also offers educational resources about fees.

Value matters too

Low cost isn’t the only consideration. Sometimes paying for advice or services can be worthwhile, especially if it helps you avoid costly mistakes, create a sound financial plan or manage complex situations. The goal is to make sure you understand what you’re paying and that you’re getting good value for it.

This article is for education only and isn’t investment advice.