Understanding how much you are paying for investments and investment advice is essential. Fees reduce your return. Over time, high fees can hinder the growth of your assets.
In the investment arena, fees are usually charged as a percentage of assets quoted in terms of basis points. A basis point is one one-hundredth of 1 percent, or 0.01 percent. In other words, 100 basis points equals 1.0 percent, and 50 basis points equals one-half of 1 percent, or 0.50 percent.
There are many kinds of fees. Some fees are transaction-based: these compensate brokers for putting clients in an investment or for executing a trade. With a commission, the brokerage firm charges a fee for each transaction.
In contrast to brokers, who charge commissions, fee-based advisers charge an annual fee based on a percentage of assets under management. The adviser is paid to manage your money and not to execute trades. If the investments perform well, the portfolio grows, and the financial adviser also does well. Unlike brokers, who charge transaction-based fees, incentives are aligned for fee-based financial advisers and their clients. Fee-based arrangements are more common than commission structures. Traditionally, financial advisors charged 1% or more on assets under management. Competition from online wealth management firms, which are also called robo-advisors, has helped bring down fees across the board. Robo-advisors usually charge 25 to 30 basis points on the assets in the account, while some are closer to 50 basis points for higher-level service and customer interaction.
For funds, the management fee depends on the type of fund. According to the Investment Company Institute, the average annual stock fund management fee in 2019 was 52 basis points. For bond funds, the average annual management fee was 48 basis points. Management fees have been coming down. Twenty years ago, the average fee was 90 basis points for stock funds and 80 basis points for bond funds, according to the SEC. Fees are lower for index funds and exchange-traded funds or ETFs. Depending on the type of index fund or ETF, the fee may be less than 10 basis points. More specialized index funds and ETFs have slightly higher fees.
The following illustrates the long-term impact of fees. For example, $1,000 earning a 7 percent return will grow to $4,322 after thirty years if the investment is in a fund charging 200 basis points. That same $1,000 earning 7 percent would rise to $6,614 after thirty years if the fund charged only 50 basis points.
Although investment fees may seem complicated, understanding them is crucial because of their impact on the growth of your money. You should know the all-in fees for any investment that you make. If you meet with a prospective financial adviser, fees should be an essential part of the discussion. Fee information is easy to find on Morningstar, online brokerage firms’ websites, and the various mutual fund marketplaces and wealth management platforms. Make sure you understand all fees, whether you invest on your own or through an adviser.
