How to Know When an Investment Fee Is Too High

When you’re focused on how well your investments are performing, it’s easy to overlook the hidden fees associated with investment services. Investment fees are the fees you pay for the services of your investment accounts and financial professionals. But how much should investment fees cost and how can you tell if you’re being scammed ? Here’s a quick overview of how investment fees work, as well as strategies for minimizing them to help you maintain greater investment returns over time.

What are the different types of investment fees?

Investment fees play an important role in the performance of your portfolio. Generally speaking, minimizing fees tends to maximize profits. But in the wider world of investing, these fees can take many different forms:

• Expense rates are calculated as a percentage of your investment in the fund and are charged annually regardless of whether you make or lose money.
• A transaction fee is charged each time you buy or sell an investment.
• Advisory fees are typically charged quarterly based on the value of your portfolio.
• Account fees vary depending on the account type and services used.

Knowing the fees you pay is important to investing wisely. Let’s take a look at how investment fees should factor into your decisions.

How much should investment fees cost?

Investors should carefully “consider the fees they pay based on the returns they receive,” says Nathaniel Donohue, a financial planner and partner at Consilio Wealth Advisors . Fees play a huge role in your investment decisions. “There are very few things you can control in the investing world, but you can control how much you pay.” Minimize fees and you can maximize productivity.

For an investor to determine whether certain fees are worth the cost, they must understand the value they are receiving. For example, let’s say you hire a financial advisor. Most financial advisors charge a fee based on how much money they manage for you, and this fee can range from 0.25% to 1% per year.

If you are looking for someone to only manage your portfolio, then a fee closer to 1% will be higher. You need to monitor your portfolio carefully and intelligently to know if its performance outweighs that 1% cost. But if your financial advisor provides additional services, such as tax advice, savings for your children’s education, or estate and retirement planning, then that 1% is probably well worth what you get. Here’s our guide to finding a financial planner who won’t scam you .

Understanding the performance of your investments

Donohue explains that the stock market where people most often invest is in US large company stocks (also known as US large caps), which are often compared to the S&P 500 Index. This index tracks the 500 largest publicly traded companies in the US. Because of how efficient this area of ​​the market is, money managers rarely outperform this index, especially over long periods of time. As a result, investors invest wisely in the S&P 500 index or ETF. These index funds/ETFs are less expensive and perform closely to their benchmarks, resulting in higher net returns for investors.

So what does this mean for estimating your investment fees? Well, since it’s “almost impossible” for an investment manager to beat the benchmark S&P 500 index, high fees of 1.5% or higher are almost certainly a steal.

Other asset classes, such as US small caps, emerging markets, real estate or private equity, invest in other markets, meaning they use different benchmarks than the S&P 500 Index. These investments can be more volatile, and there are managers who historically, they have performed well relative to their respective benchmark, Donohoe said. In this case, let’s assume you pay a higher than average fee, around 1-2%. If your fund generates returns well above the benchmark, then those above-average fees are likely worth the huge profits you’re making.

Donohue notes that, naturally, there will be managers receiving 1-2% fees who will still perform worse. With such a high interest rate and such a low return, you will not get a good deal.

The bottom line is that investors need to understand how their investment is performing relative to the relevant benchmark when analyzing the results obtained and the fees paid. If investors are ever unsure, they can default to investing in a benchmark index fund/ETF because they can control keeping their costs low. As Donohue puts it, “control what you can control.”

How to Minimize Investment Fees

Here are some tips to help make sure your investment fees are worth it:

• Stick to low-cost index funds and ETFs. Actively managed funds have higher expense ratios.
• Buy and hold investments for the long term to reduce transaction fees.
• Look for low or no advisory fees from automated digital advisors.
• Choose tax-advantaged accounts, such as 401(k), with lower fees.
• Meet minimum account requirements and combine accounts to potentially reduce or eliminate fees.
• Review fees annually and evaluate whether you are getting value for money.

The bottom line is that as an investor, fees are one of the few things you can control. Minimizing investment costs means you’ll have more money working for you over time. Do your research and push for transparency in financial institution fees. And if you’re investing with a financial advisor for the first time, be sure to read about the difference between fee-based and fee-based advisors .