Portfolio Toolbox
Compound interest is the 8th wonder of the world. - Albert Einstein

Investment Expenses

Investment expenses are the cost of doing business in the markets. Investment expenses are relentless and ongoing, and occur even during years with a negative return. Some expenses are avoidable, however you must bear the risk of managing your own portfolio if you choose to do so. This page discusses various investment expenses and alternatives to avoid them.

Management Fees

Financial advisors charge a management fee for investment advice. There are many advisors who charge 1% of your portfolio total per year. Some advisors work on a fee-only basis and charge you an hourly rate to provide advice. While 1% per year does not sound like much, a 1% fee assessed over 40 years will redirect over 30% of your returns to your advisor. You take all the risk and your advisor gets 30% of your returns. If you decide you would like to hire a financial advisor, consider finding a fee-only financial advisor who is a fiduciary. If you decide you do not need a financial advisor, here are some ideas to help you get started.

Commissions

A commission is a one-time only flat fee or fixed percentage of a transaction charged by brokerage firms in order to execute said transaction. For individual stocks or ETFs, commissions can be charged to buy / sell these securities. The advent of high frequency trading has reduced commissions to zero or near zero on many brokerage platforms. If your brokerage charges commissions, consider shopping around for a brokerage firm with lower commissions.

Sales Loads

Investment companies issue and redeem mutual fund shares. Some investment companies charge a sales load to buy or sell mutual funds. You can think of a sales load as a commission to buy or sell a mutual fund. These charges can be up to 9% per the Investment Company Act of 1940 or 8.5% per FINRA rules. Investment companies have created various share classes to give investors a choice of how much they want to pay in expenses and when. Here are three common share classes:

Share Class Load Expense Ratio
A front-end lower
B back-end higher
C none medium

A front-end load is charged when purchasing shares. A back-end load is charged when selling shares. A back-end load is also called a CDSC or a surrender charge. Back-end loads generally decrease over a seven year period to discourage investors from short-term trading. Some mutual fund families allow investors to convert Class-B shares to Class-A shares after the surrender charge reduces to zero which lowers ongoing expenses. Some mutual funds have breakpoints in which investors are charged a lower expense ratio if a certain dollar amount is invested.

Some mutual funds do not charge sales loads and are called "no-load" mutual funds. There are no fees to buy or sell no-load mutual funds, however some brokerage firms charge a fee or commission to buy / sell competitor mutual funds. Some no-load funds contain purchase or surrender fees which are paid back into the mutual fund to protect other investors in the fund from excessive short-term trading expenses. Information regarding sales loads can be found in the prospectus for each mutual fund.

Expense Ratios

Mutual Funds and Exchange Traded Funds (ETFs) charge a fee for operating the fund called an expense ratio. This fee is baked into the daily price (NAV) of the fund and not paid separately. Included in this fee are 12b-1 fees to cover marketing & distribution, and other overhead for managing the fund. Expense ratios are expressed as an annual percentage rate. Expense ratios can be as low as 0% for some index funds. Expense ratios lower than 0.10% (or 10 basis points) are very low. Expense ratios for some funds can be as high as 1% or more.

It is important to note that some mutual funds are more expensive than others, even though they invest in the same underlying stocks. For example, Vanguard has an S&P 500 index fund that charges 4 basis points while some investment companies charge over 100 basis points (1.00%) for the same product.

There are no expense ratios for holding individual stocks. The only expenses for individual stocks are the commissions you pay to a broker to complete your transaction.

Compound interest is the 8th Wonder Of The World. He who understands it, earns it. He who doesn't, pays it.Albert Einstein