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Bloomberg: An Investor’s Guide To Fees & Expenses
Aspire, Investments, Personal Finance | 30 October 2015

About 140 years ago, a Philadelphia retailer named John Wanamaker figured his customers and salesmen had better things to do than haggle, so he assigned one price, “plainly marked,” to every product.The price tag caught on nearly everywhere.

The notable exceptions include airfares, mattresses, and financial services.

It’s ridiculously hard for investors to figure out what they should be paying for financial advice, mutual funds, and retirement plans. A fee that eats up 1 percent of your assets every year might not sound like much, but it sucks money from your account year after year. If you invest $10,000 and earn 5 percent a year, that 1 percent fee will cost you a total of $1,487 after 10 years and $4,622 after 20 years.

Source: Bloomberg

How do you know if you’re paying too much?

This brief guide details the typical costs of various investment products and services in the U.S. If you’re overpaying, you’ll be more successful in negotiating a better deal if you know what you’re talking about.

And if you prevail? Think of it as an instant investment return.

Mutual funds

Source: Bloomberg

Actively managed funds:
 Here you’re paying a company for the investing skill of its fund managers. An expense ratio is your annual cost, compared to the assets in the fund. For bond funds, investors pay an average of $63 for every $10,000. The typical fund charges much more—one in 10 equity mutual funds charges more than 2.08 percent a year—but most investment dollars favor less-expensive options. The cheapest 25 percent of U.S. equity funds held 74 percent of assets at the end of 2014, according to the Investment Company Institute (ICI).

Index mutual funds: Funds based on indexes are cheaper; rather than hire a professional to pick investments in an effort to beat the market–which most managers can’t do consistently, anyway–these funds invest in a set, broad range of bonds or stocks, such as the Standard & Poor’s 50-stock index and the Barclays U.S. Aggregate Bond Index.

The expense ratio isn’t the only fee to beware. Some brokers will slap a “sales load” on fund purchases or redemptions. The average load fund will charge a front-end sales load of up to 5.4 percent, according to ICI. More and more investors are turning to no-load funds; $175 billion left load funds last year, while $341 billion flowed into no-load funds.

Transaction costs are largely invisible to investors but can take a big bite out of returns, depending on how often managers buy and sell holdings and which assets they’re buying and selling. Studies have come up with differing estimates of the impact of transaction costs. John Bogle, founder of Vanguard Group, estimates that, based on those studies, transaction costs lower returns of actively managed funds by 0.5 percent a year. Such costs should be minimal for index funds, if they’re well run.

Exchange-traded funds

The average ETF costs 0.5 percent a year. That’s the average expense ratio for U.S. non-leveraged ETFs, according to Bloomberg data.

ETFs trade on an exchange all day, unlike mutual funds, whose net asset value is calculated at the end of the trading day. Because the vast majority of ETFs invest based on an index, most ETFs’ costs are similar to those of index mutual funds. New, actively managed ETFs bring up the average, and so do specialty ETFs such as commodity funds. They can have expense ratios of 1.5 percent or more.

401(k) plans

When employees have a retirement plan at work, they are charged for two services. First comes the cost of running the plan: paperwork, marketing, mailings. Then there are the costs of managing investments, usually through mutual funds.

For both services, workers in small retirement plans tend to pay far more than employees in large plans. Small companies have much less bargaining power and are rarely savvy enough about these matters to seek out low-cost options.

Source: Bloomberg

Administrative costs aren’t always spread evenly among employees because investors who choose low-fee index funds often avoid “revenue-sharing” fees. Those charges are often included in pricier funds’ expense ratios, but they actually help cover the retirement plan’s administrative costs.

Financial advisers

If you sit down with a financial adviser, expect to pay for his or her time, one way or another.

Sometimes these charges are hidden in commissions paid by mutual fund companies or insurance companies. If an investor is paying higher-than-usual fees on a fund or insurance product, some portion of those charges is probably being sent back to the broker who recommended the investment. Investments sold in this way are also likelier to underperform other investments by 1 percent or more.

Directly paying an adviser can result in less biased investment advice. The typical charge for a fee-only investment adviser is 1 percent a year. Investors with millions of dollars can end up paying a lot less, at least in percentage terms.

Some advisers will charge for their time or for a particular service, rather than a percentage of assets they manage. For example, they might charge $250 an hour, or a flat fee of $1,000 to work up a financial plan.

Online advice

Both startups and more established firms are trying to use technology to lower the cost of giving advice. One way is through smart Web design. A website, often called a “robo-adviser,” asks investors questions and then uses algorithms to recommend a portfolio for them. This can cost as little as 0.25 percent of assets a year for investors with less than $100,000 at startups such as Wealthfront and Betterment.

This year, Charles Schwab launched its own robo-adviser, Schwab Intelligent Portfolios, that charges no advisory fees. Investors are charged fees on the underlying investments, many of which are Schwab ETFs.

Other companies use call centers to give customers advice more cheaply than through an in-person adviser. The Vanguard Personal Advisor Service charges 0.3 percent a year for access to advice delivered both over the phone and through the Web.

Brokerage charges

Online discount brokerages will apply flat service charges of $5 to $10 to buy and sell stock and make ETF trades. Traditional brokerages may charge more, and may slap sales loads of up to 5 percent on fund purchases.

Startups have popped up to offer lower-cost services to traders. Motif Investing charges a $10 commission to buy or sell a basket of up to 30 stocks or ETFs. Some venture-capital-funded startups are forgoing commissions on individual stock trades.

Hedge funds

Though recent underperformance has caused some investors to think twice aboutwhether hedge funds are worth it, many wealthy investors and institutions still rely on them to diversify portfolios.

The conventional wisdom is that hedge funds charge “two and 20″—2 percent of all assets and 20 percent of any gains. But data from Hedge Fund Research show that average fees are lower than that—and falling. The average hedge fund management fee in the second quarter was 1.51 percent, down 0.07 point from five years ago. Incentive fees have also fallen, with the average fund now taking 17.8 percent of all gains, not 20 percent.

Source: Bloomberg

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