You know that investment costs can add up over the decades—you’ve heard it a thousand times. But the reality is that your money could be invested for far longer than the standard 30-year period that many people cite when they talk about your all-in cost.
To digest the full impact that all your investing costs can have, consider them over the course of 40 or even 50 years. True, expense ratios have dropped in recent years, but it pays to ask the professionals you work with to run the numbers so you can weigh the full impact of all your investing expenses in light of your overall financial goals.
Hypothetical costs over your investing lifespan
Consider what could happen over the course of four decades of investment: Suppose that at age 45, you invest $1 million in a professionally managed portfolio. If you assume a 6% rate of return and all-in costs of, say, 2% a year, you’ll end up with about $4.8 million by the time you're 85.
However, in this hypothetical example, if your all-in cost was only 1% a year, your investment would grow to about $7 million after 40 years, a difference of $2.2 million. And that’s huge.
Granted, investment costs are a part of financial life. Often you can pay more for a particular manager’s or advisor’s skill. But as you can see from these numbers, it’s truly essential to be fee-smart, given not only your portfolio’s costs but also how those costs add up over an extended period of time.
“After all, costs represent dollars that aren’t being invested,” says Michael Iachini, head of manager research for Charles Schwab Investment Advisory.
“Many investors don’t fully understand their investment costs,” says Tony Davidow, asset allocation strategist at the Schwab Center for Financial Research. “If you are signing up for an advisory program, read the advisory agreement. If you are buying a mutual fund or exchange-traded fund (ETF), look at the prospectus.”
What costs should you look for when going through those documents, and what can you do about them? While you may not pay these charges directly, they still affect your potential return. The key is to be aware of what you’re paying and, when necessary, investigate lower-cost options. Here are some common examples of investment costs:
- Commission: Paid when buying or selling a security through a financial institution, in compensation for services. “The smaller your investment and the more frequently you trade, the more important the commission becomes. Look for ETFs or mutual funds that trade commission-free if you plan to make a small investment or hold the investment short-term,” says Michael.
- Annual operating expenses: Paid for the management and marketing of investment products such as mutual funds and ETFs. These expenses can include management fees, 12b-1 fees (paid by the fund out of fund assets to cover distribution expenses and sometimes shareholder service expenses) and various other expenses. Michael points out that if you plan to hold a mutual fund or ETF for more than a year, this is probably the most important cost.
- Bid-ask spread: The difference between the price at which you can currently buy a stock or an ETF (slightly higher) and the price at which you can currently sell the same security (slightly lower). On each round-trip trade (a buy followed by a later sell), you effectively “pay” the full bid-ask spread as a cost.
- Markup: The difference between the prevailing market price for a bond and the price a customer pays or receives. Certain industry rules require your investment firm to disclose the markup on your trade confirmations for principal trades in covered securities (municipal, corporate and agency bonds) when the broker-dealer has an offsetting purchase or sale (by the firm) on the same day.
- Transaction fee: Much like a commission, a transaction fee is an amount paid for a given transaction.
- Investment advisory fee: Paid annually for an investment advisor managing your portfolio or providing advice.
- Sales load: Paid to a financial institution for buying or selling securities (typically mutual funds) on your behalf.
- 401(k) fee: An expense for operating and administering a 401(k) plan, which is in addition to the commissions and annual operating expenses of the investments that you may hold in your plan.
- Taxes: Although not a fee per se, they can impact your overall net gains. Consider tax-efficient investment strategies to minimize your tax burden.
While a more passive, low-cost portfolio will likely come with lower fees, that’s only one layer of costs. Paying for financial advice can bring its own charges, with the potential to erode investment returns. As with any other kind of fee, it’s important to know what you’re paying for and that you’re getting good value for your money.
Tony encourages investors to understand all their investments costs. Some fees are transparent but others are imbedded and difficult to understand. He recommends asking questions and advocating for clarity about investment costs. So don’t be shy about asking your financial professional what you’re really paying. It matters—a lot.