New to investing? Watch out for these costs

There are two major ways to put more money in your pocket: 1) Earn more and 2) Spend less. When it comes to investing, many people focus on the first category, aiming for higher returns. But oftentimes, mom-and-pop investors overlook fees, especially recurring fees, which continually eat away at their hard-earned investing returns.

Investing fees are like paying for parking...

Whether you’re circling the lot or hunting for street parking, you’ll probably have to pay at least a little bit. Some parking lots may offer valet service, or they might be closer to your final destination. But you could end up paying a premium. Meanwhile, there might be metered spaces just around the corner. If you’re willing to put in a little legwork, you might reduce your fees and keep more money for the future.

The fees and the various costs associated with your investments might seem small — they’re often 1% or less of your assets — but don’t be swayed by the low number.

Let’s say you invest $10,000 today, and you have a choice between investment advisors. There’s Pete’s Pricey Services (he charges 1% of your assets annually) and Riya’s Reasonable Rates (she charges 0.25% of your assets each year). We’ll assume that Pete and Riya are equally skilled at their jobs, providing identical services and results.

In year one, Pete charges $100 and Riya charges $25. The difference ($75) probably doesn’t seem that big.

But remember, Pete and Riya charge for their services year after year. Assuming their fees remain the same, after 40 years, you would’ve paid Pete $4,000 (that is, $100 x 40 years). By comparison, you would’ve paid Riya just $1,000 (that is $25 x 40 years). That’s a difference of $3,000.

Every dollar you save in fees is money you could keep investing — So, that $3,000 in savings could eventually correspond to much more. Assuming you save $75 per year by choosing Riya over Pete, and that over 40 years, your investments grow at an average of 4% per year, your $3,000 in savings could grow to about $7,500.

Even a small fee can really add up over time. So, it’s important to ensure that you’re getting your money’s worth from a financial advisor.

As an investor, it’s important to do a little research, figuring out what services are available and whether they’re worth the money. While it’s tempting to put things on autopilot, or rely on the good faith of financial advisors, you can hold them accountable by asking questions and reviewing their performance.

Here are some questions to ask a financial professional before engaging with them:

• What’s your experience? How were you trained?
• What’s your investment philosophy? Are you a risk-taker or are you more conservative?
• What’s your typical client like? What’s their average net worth? Can you provide me with references?
• How are you paid? (Common ways: Commission, percentage of assets)
• Do you receive compensation for selling any firm’s products?
• How much will I have to pay to do business with you?

In investing, there are two big types of fees—transaction fees (aka “shareholder fees”) and ongoing fund operating fees.

Transaction fees

You may incur a transaction fee when you trade shares. Common transaction fees include commissions, sales charges, and redemption fees. A commission is a fee that a financial professional (like a broker) takes for serving as your agent in a transaction.

A sales charge is a fee paid to a broker for processing the purchase or sale of shares in a mutual fund. It is similar to a commission.

A redemption fee is a charge paid to a mutual fund company when an investor sells his or her shares in the fund. It is generally related to compensation.

Ongoing fund operating costs

Ongoing fund operating costs cover things like legal, accounting, and administrative costs.

Management fees

Management fees are costs that fund managers charge to handle your investments. These fees may go toward the salaries of investment advisors.

Other fees

Besides management fees and commissions, money managers may also charge you fees for things such as not maintaining a minimum balance, money transfers, and marketing (these are 12b-1 fees associated with mutual funds). If you don’t understand a fee, ask for an explanation.

Whatever investment strategy you choose, make sure that you understand the associated costs. This may help you make informed decisions, and ultimately, it could help you keep more money.

Before you invest, you may want to review the expenses associated with your financial advisor, fund, or account. Generally speaking, when you open a retirement or brokerage account, you may examine the company’s fee schedule. And when it comes to advisors or investments themselves, you may ask for an investment advisor’s disclosures, and perhaps for the prospectus for an exchange-traded fund (ETF) or mutual fund.

Disclosure

Rates of return in this article are for illustrative purposes only and do not necessarily represent any specific investment.