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Investing

4 Fund Fees Every Investor Should Know

Understand what you’re paying to invest, and the options available to you.

July 03, 2019 • 4 minute read
BrightPlan Blog

As a Portfolio Analyst for Plancorp, I get a steady stream of emails from fund companies inviting me to learn about their fantastic and sophisticated investment strategies.

There’s a common theme in the pitches. The specialized funds that promise the most tend to charge significantly higher fees. That wouldn’t be a problem if they could deliver on the promise, but both my experience and years of research point to high fees being a predictor of worse performance, not better.

Paying lower fees for a better product isn’t normal. Usually, you get what you pay for. For example, when you go out for a nice steak dinner, the more you pay the higher quality steak you get. With investments it’s the opposite. Because fees drag on your returns, as John Bogle, founder of Vanguard and prophet of low-cost investing would say, “When investing, you get what you don’t pay for.”

You need to know your investment fees

When we begin managing a client’s investments, we review every holding they’ve accumulated over the years. A couple of astonishing facts consistently arise. First, it’s rare that a client knows what they are paying in fund fees. And second, time and time again we see that high fee-funds fail to deliver better performance than low-cost alternatives over the long term.

As more investment funds become available and fees continue to decrease, it’s important to understand what you’re paying to invest, and the options available to you. In this first post of a series on investment fees, we’ll walk you through the most common fund fees.

What fees are you paying anyway?

Mutual Funds and Exchanged Traded Funds (ETFs) are pooled investment vehicles. Overall, this structure is great for investors. By pooling your money with thousands of other investors, you can reduce transaction costs, benefit from professional management, and gain diversification you couldn’t get on your own.

But as managers do their job they incur expenses, which in turn are charged to the individuals who invest in the fund. A host of expenses come with managing a fund: accounting expenses, fund manager salaries, marketing expenses, legal fees, and many more.

To simplify reporting, the fund company combines expenses and reports them as a percent of the total assets within the fund, which is referred to as the “Expense Ratio.” Fund companies calculate their expense ratio by using the following formula.

 

expense ratio

 

To give a simple example, a $100 million fund with $1 million of expenses will have an expense ratio of 1.00%. If you had an average of $1,000 invested in the fund for the year, you can multiply your investment by the expense ratio ($1,000 x .01) to see that the fees would reduce your total investment by about $10.

But if you’ve ever looked at your investment account statement you won’t see any direct investment expenses. That’s because the fee is charged against the assets in the investment pool. This automatically reduces the value of the fund, and therefore your investment.

Investor Dictionary: four fund fees to know

The expense ratio is universal across funds, but there are other, less common fees as well. You can check your fund fees in the fund prospectus, on a financial website like Yahoo Finance or The Wall Street Journal, or your investment custodian’s website. To help you navigate which numbers are important and what they mean, here are the most common terms you will find with their definitions.

  • Gross Expense Ratio: The total annual cost associated with running the investment vehicle or fund.
  • Net Expense Ratio: The annual fee that investors actually pay to invest in the fund. It often equals the gross expense ratio, but can be lower if the firm waives fees to attract investors.
  • 12B-1 Fee: An additional annual service fee used to pay for costs associated with fund distributions, marketing, and commissions paid to brokers.
  • Load: A sales commission charged to an individual when they buy (front load) or sell (back load) shares of a mutual fund.

What fees should you be paying? Just the net expense ratio. Remember, low-cost funds keep more of your money working for you than high-cost ones. So, skip any fund that charges a 12b-1 fee or includes a load. This is why BrightPlan portfolios are built from no-load funds from Dimensional Fund Advisors and Vanguard.

What to do if you’re paying too much

Investment companies will continue to aggressively market their lucrative high fee funds. Occasionally the fund managers who swing for the fences will connect, drawing in crowds of excited investors. That’s why it’s crucial for you to understand and consider the investment fees you’re paying.

BrightPlan makes it easy to check the net expense ratios on all of your funds. Just link all of your investment accounts to BrightPlan to get your fund fee analysis. We’ll show the net expense ratios on each mutual funds and ETF in your portfolio, and give you insights into your total annual fund fees.

If you are paying more in fees than you’d like, consider opening a BrightPlan Investment Account, or chat with a financial advisor from Plancorp to see if moving your investment accounts can save you money in investment fees.

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