Investments come in many shapes and sizes, and so do the fees that are associated with them.
New regulations require fees to be more prominently disclosed, but many Americans still have no idea how much of their money is being invested and how much goes to cover administrative costs.
“People are pretty knowledgeable about the fees that are transparent like investment management fees and transaction fees,” says Chris Cook, founder and president of Zero Commission Portfolios. “Where I see lots of clients over paying is on those fees that are buried away.”
The amount to fees varies with investment type. Typically, passive investments like an index mutual fund or vehicles that don’t require a person to actively manage the money come with lower fees.
While people can choose passive investments in their retirement funds, many 401(k) s are actively managed. According to FeeX, a new website trying to create more transparency around fees, 7 in 10 Americans think their 401(k)s don’t have any fees. In reality, the company claims workers lose $155,000 in fees over the course of their career. What’s more, in 2012, the amount of money spent on financial services fees was $600 billion, with $100 billion coming from mutual funds and $35 billion stemming from 401(k)s.
“As consumers who are paying, we should know exactly what the cost is,” says Yoav Zurek, chief executive of FeeX. “If you buy a TV, you know the price for that TV in dollars” and it should be the same with investment fees.
There are all sorts of fees investors get hit with from commissions when working with a stock broker. Regardless of the type of fees, W. Kirk Taylor, chief investment strategist at 1st Portfolio Wealth Advisors, fees associated with a passive fund like an exchange traded fund should be somewhere in the 25 basis points or the one-quarter of 1% range.
Some funds can carry fees as low as five basis points while more popular investments can charge fees of as high as 50 to 60 basis points, on average, he says.
For actively-managed investments, Taylor says the fees, on average, tend to be around 1.5% of the investment amount. “In general, lower fees translate into higher returns. Active managers can add value during certain market conditions but investors should recognize that for an actively managed mutual fund the manager has to generate a 1.5% return before his or her shareholders make any money whatsoever.”
Although investment firms have to disclose their fees, investors have to be their own advocate and ask about them and make sure they understand how much of their money is covering these costs. It’s pretty unlikely that a mutual fund company is going to offer up the number without being prodded.
Combing through a prospectus can also find the answer, but it can get pretty complex. Experts say a mutual fund provider should be willing to provide the answer. “The fees are listed in the prospectus, but they are not really easy to understand,” says Cook, pointing to the expense ratio fee as an example. Investors don’t see that fee deducted on their statement every month, yet Cook says that’s probably the largest fee they are paying. The expense ratio is the percentage of the fund’s assets that are used to run the mutual fund.
Cook advises investors understand all the fees and whether it’s actively or passively managed before making an investment. This information is particularly important because a highly active fund can bring hefty fees.
“Investors really have to be an advocate for themselves,” he says. “They have to do their due diligence and ask for every possible fee. You want to know what the management fee is, if there is a financial planning fee for coordinating the account, and the transaction fees.”