Fees and costs can have a significant impact on investment portfolios. Unfortunately, many people don’t know the full extent of what they are paying. Our dashboard can help you quantify direct fund fees, but there are often many hidden costs. You should have a firm grasp on both before making any investment decision.

Mutual Fund and ETF Costs

Mutual Funds and ETFs have four main sources of costs:

• Expense Ratio: This is the direct fee charged for asset management, typically ranging from near 0.1% to 2.0% per year. For example, if a mutual fund has an expense ratio of 1.0%, the fund will deduct $10 each year for every $1000 you have invested. The average mutual fund has an expense ratio of 1.15%, according to Lipper. As a rule, passive funds which attempt to track an index have lower expense ratios, while active managers trying to beat a benchmark have higher expense ratios.
• Load Fees: Some mutual funds deduct a percentage of assets upfront (front-end) or when the fund is sold (back-end). Load fees are essentially commissions paid to the broker who sold them. Many financial professionals consider load fees unfair to the client.
• Trading Costs: These are hidden costs. When a portfolio manager trades inside a fund, the fund must pay commissions to the executing broker. Often more important is the “spread”. Each stock has a bid and an ask price. The spread between them is essentially lost when buying and selling. This can be significant, particularly for small cap stocks. Some studies have shown internal trading costs average over 1.0% per year in the average active mutual fund. Passive index funds tend to trade less and, therefore, have lower trading costs than actively managed funds.
• Market Impact: Another hidden cost. When a large fund buys a stock, it often pushes the price higher. When it sells, it pushes the price lower. This detracts from performance and can be a significant drag in high turnover funds.

Many mutual funds have multiple share classes where the only difference is the fee. “A-Shares” typically have high front load fees and lower ongoing fees. “B-Shares” have back-end load fees which diminish to zero over time. During this window they often have higher ongoing fees than “A-Shares”. “C-Shares” have no load fee but higher ongoing fees in perpetuity.

We believe active mutual funds were a great innovation for their time but are no longer appropriate for investors with more than $100,000 in liquid assets. Most active mutual funds come with high costs, but fail to beat their benchmarks. In addition, they tend to be horribly tax inefficient. We believe using passive ETFs or a properly constructed portfolio of individual securities can be far superior.

Advisory Costs

If a professional is managing your portfolio, you likely pay a percentage of your assets as a management fee. These fees typically range from less than 1.0% to more than 2.0%. For many investors, these fees can be well worth paying, but the quality and level of service provided varies greatly. Some advisors will help you with asset allocation and financial planning topics while others simply pick stocks or funds. Paying 1.5% or more for advisory costs is generally considered excessive. Many advisors charge high fees and then buy active mutual funds which also charge high fees. This double layer can be very costly.

Some brokers charge an advisory fee and also earn commissions on product sales or trades. This is a dangerous situation because this person has a significant conflict of interest.

If possible, make sure to use a fee-only advisor, not a broker. If you are not paying an explicit fee, your advisor is almost certainly making money on the products you buy. Many mutual funds pay kick-backs to advisors for recommending them.