Sticker shock: Your investment fees are more than you think
When investors come to FutureAdvisor, an online financial advisor that offers a free fee-evaluation service, their biggest surprise is not how much they're paying in fees—it's that they're paying fees at all.
Despite decades of work by regulators pushing greater disclosure of fees on mutual funds, most investors remain blissfully unaware that they are paying hundreds, if not more than $1,000, in investment fees each year.
"People think because there's not a number, like the one above the button on Amazon.com, that they're not paying anything," said FutureAdvisor CEO Bo Lu. "Just because it's not above the button doesn't mean you're not paying it."
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A typical American fund-holding household, with $120,000 in mutual fund assets, paid $873 annually in ongoing fees for its mutual funds in 2012, the latest year available, based on an analysis by Lipper.
That doesn't include sales charges or other fees, which could amount to several hundred dollars more a year. Front- and back-end commissions and fees can each be as high as 4.75 percent and 5 percent, respectively, Lu said.
The average ongoing fees paid by the typical household have dropped since 2000, but that is mostly due to the adoption of passive index-based funds. The fees paid by investors in actively managed mutual funds dropped slightly between 2000 and 2012, falling from .99 percent basis points to .82 percent, according to Lipper. A different analysis of fees on actively managed funds published by Princeton University economist and Wealthfront chief investment officer Burt Malkiel last spring showed that fees on actively managed mutual funds rose by about one-third between 1980 and 2010, to .90 percent from .66 percent.
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Don't fall into the trap of thinking the dollars are small because the percentages are, and don't count on a fund company, financial advisor or broker to be up front with you about fees, said Barbara Roper, head of investor protection for the Consumer Federation of America, pointing out that investors usually receive their prospectuses after they buy.
"If you want people to focus on fees, you would provide that information before they buy and in a form that they can easily understand. That's not done," Roper said.
So how do you cut your fees?
• Become aware of the size of your fee burden. After a year like 2013, in which the S&P returned 30 percent, it's easy to get complacent. A rising market lifts all boats, but the boats that win the race have the lightest weights. You can't control the market, but you can control your fees. Assuming the typical investor had invested that $876 every year instead of paying it to the investment company, he or she would have had an additional $80,000 in her portfolio after 30 years, assuming a 6 percent average return.
• Think of your fees in dollars, not percentages. "There is all kinds of behavioral economics research that shows people tend to think a figure quoted in dollar figures is larger: $100 is more than 1 percent, even when they are the same," Roper said. Think about how much time you put into considering the costs of a purchase like a washing machine, dryer or refrigerator—those are purchases made once a decade or so. You spend that much on your investment fees every year.
• Comparison shop. Just as you might buy a washing machine from a discount store, one way to consider your fees is to consider whether you can get the same service for a cheaper price. For instance, in 2012 active and passive investors earned almost the same: 14.42 percent for investors in passive funds, on an asset-weighted basis, and 13.10 percent for investors in active funds. But the Lipper analysis showed that active investors paid $985 for their returns, and the passive investors paid only $216—less than a quarter of the price.