What’s the real cost of investing?
You can pay vastly different amounts to invest, but it’s not always clear how these fees add up. Keep in mind fees are not inherently bad, as long as they are outweighed by the benefit. In this vein we will compare commissions, sales, and transaction fees; we will assume that you only buy quality mutual funds whose internal fees are offset by increased profits (reality you should do better but we will cover that in another article).
Know we will use an example to see how these fees add up.
Assumptions: You invest a fixed $5,500 per year (current standard IRA contribution). You receive an average return of 7% before fees for 40 years. How much will you pay in fees and how much will that impact your investments?
Mutual Funds A-Shares: A shares are often dismissed as expensive because you pay all the sales charges/fees up front. They often start as high as 5.75% but decrease the more you own and once you obtain $1,000,000 the fees equal 0%. This sounds like a lot, but it’s not that bad. If you start with > $1M there is no fees or if you start with $1k grew it to a million you would only pay $57.50. Since you don’t pay fees on your profit the more you make the less you pay. So in 10 years you have $75k and paid $2,832 in fees; in 20 years you have about $227k and paid $4,868; and in 40 years you have about $1.152M and paid $7,178 in fees and never pay any more.
Transactional: Using the same scenario with a $15 transaction fee twice a month (common for an auto ETF index purchase with semimonthly pay; or a monthly purchase of an S&P and bond fund). After 10 years you have $74k and paid $3,700 in fees; in 20 years you have about $223k and paid $7,200; and in 40 years you have about $1.124M and paid $14,400 in fees and continue pay indefinitely. Of course you can find ways to reduce this; also if you buy several securities at time to diversify or trade stock regularly you could spend significantly more.
Fiduciary (flat fee account): These accounts charge a flat or graduated annual percentage that is normally between 0.75% and 1.5% In this scenario, we will use a 1% flat fee and keep the other factors the same. After 10 years you have $74k and paid $3,600 in fees; in 20 years you have about $210k and paid $18,200; and in 40 years you have about $908k and paid $120,831 in fees and continue pay indefinitely. The reality is this number is quite low. Most account charge more than 1% if you have less than $1M; often won’t open an account with less than $200k; and the fees really start adding up if you have more than $1M even if they discount the rate below 1%.
Think about this scenario, at least one spouse in a couple will typically spend about 30 years in retirement. If their high three years, married filing jointly, were around $300k you would expect them to have retirement savings of at least $3M. They pay an advisory fee of 0.75% that equals $22,500/year if they paid this for 30 years that would equal $675k in fees during retirement and they likely spent at lest that much during the accumulation period $1.35M they could have had to invest throughout their lifetime and pass on with interest.
The point is you should be aware of the one time fees but even fees as high as 5.75% are not a big issue it’s the fees that affect the principal and earnings on a repeating compounding basis that really add up and damage a portfolio. Most families don’t make $300k, but all the more reason to save and invest the money you have in a cost effective manner. If you make $100k per year it’s not unreasonable to save your money and invest in a conservative manner and still be able to retire with more than $2M.
I will talk more about fees and evaluating other investment products in other articles. Also, I will have more on other ways you can save money, increase returns, and mitigate risk.