We see it all the time: You decide to ramp up your investment strategy. You hire a broker, and you wait for the money to roll in. You see your return percentage, and you celebrate. That’s all just money in the bank, right? Wrong. You forgot to consider the hidden investment fees.
Hidden Investment Fees Everywhere
Many investments come with fees, and too often, those investment fees are not advertised or discussed between broker and client. They’re hidden, and you don’t know how much you’re shelling out until you start to examine your statements. That’s when you discover that, while you thought your portfolio was up 6 percent for the year, your return is actually 4.5 percent — because your hidden investment fees totaled a whopping 1.5 percent.
In the world of investing, we believe knowledge is power, and transparency is key. So, we broke down our list of the top five hidden fees you’ll likely encounter as you invest.
Hidden Investment Fee #1: Loads
When it comes to the hidden fees in mutual funds, loads are a big culprit. They come in two basic varieties: front-end loads and back-end loads.
A front-end load is a cost incurred at the time of purchase. Consider it a commission on the sale of the mutual fund. It’s deducted from the investment amount, which decreases the amount of your initial investment.
A back-end load comes, as the name implies, at the end of your investment, or when you decide to sell your shares in the fund. There’s a time element involved, and the amount you owe decreases the longer you take to sell — an incentive to hold onto your shares. For example, if your fund has a 6 percent back-end load, you would pay the full 6 percent if you sold in the first year. The second year, you’d pay 5 percent. If you make it to year seven, you pay nothing.
There are some who would argue that a load is best thought of as the price you pay for using a strong broker. But there is no evidencethat load funds perform better in the marketplace. You should be aware that loads are one type of hidden investment fees that you can avoid in many cases. Consider shopping around for another option: no-load mutual funds. They exist, and they are a viable, fee-free investment option.
Hidden Investment Fee #2: 12B-1 fees
This is another hidden investment fee in mutual funds that might be unknown to you. The name sounds very technical, but these fees are anything but. The 12B-1 fee goes toward marketing and promoting the fund. And by some estimates, they account for nearly $10 billion in investment fees each year.
Not every fund comes with a 12B-1 fee, but if you invest in one that does (about 70 percent of all mutual funds), you’re essentially paying for the fund to advertise itself — which can come as an unpleasant surprise when you start to dissect your statement. These are another class of hidden investment fees that can be avoided by shopping for a no-fee option.
Hidden Investment Fee #3: Management fees
A management fee is the fee an investment manager charges to manage a fund — selecting the stocks, managing the portfolio, building a profitable investment vehicle. This is one of those hidden fees that’s virtually unavoidable. After all, people don’t usually work for free. But you do get a choice in how much you pay. The management fee itself can vary significantly between funds — usually between 0.5 percent and 2 percent. And before you think that an investment manager charging a higher fee will be the best option for your bottom line, consider this: It doesn’t matter how smart an investment manager is; they can’t beat the market every single time. And just like higher salaries do not always equate to better employees, we’ve yet to see evidence to support the argument that higher-expense funds outperform lower-expense funds.
Hidden Investment Fee #4: Trade commissions
Trade commissions are different than the commission a broker might earn for selling you a particular fund or product (click here to read our post on the benefits of fee-only investment advisors). Trade commissions are fees a broker charges you when you buy or sell securities. Generally, they fall in the $5 to $35 range and are largely unavoidable.
There are exceptions, however. Some brokers will offer a promotion for new customers, allowing them to make a limited number of commission-free trades. Some brokers offer commission-free trading all the time. Some even have ETFs that trade with no commission.
Again, awareness is key. Most of us will end up paying trade commissions, but it’s best to have a full understanding of the impending cost.
Hidden Investment Fee #5: Account fees
When we think of account fees, the phrase nickel-and-diming comes to mind. That’s because these fees charge investors for everything from receiving paper statements in the mail to letting your account go inactive. Some even charge an annual fee just for having an account. Individually, they are small, but added together, they eat into your return.
Understanding your investment goals, as well as your broker’s fee structure, can help you avoid unnecessary costs. For example, if you don’t plan to trade frequently, choose a broker who doesn’t charge for inactivity (which can cost $200 a year or more). You can steer clear of brokers who charge annual fees (up to $75 per year), and you can opt for emailed statements over paper (a savings of $1 to $2 per statement) to reduce these hidden investment fees.
They say you’ve got to spend money to make money, and that’s as true in the investment world as it is anywhere else. But you don’t have to let brokers and investment firms blindside you with hidden investment fees. Go into your investment journey with your eyes wide open. As always, we’re here to help.