Investment costs matter because every dollar paid in fees comes directly out of your returns. Whether those costs come from a financial advisor or the investments themselves, even seemingly small fees can have a major impact over decades. Cutting costs where possible can leave you with significantly more money over the long run.
One of the easiest ways to keep costs low is to use broadly diversified index funds. Many index funds from firms like Vanguard, Fidelity, Schwab, BlackRock, DFA, and Avantis charge extremely low expense ratios, with some costing just a few basis points and a handful even charging no expenses at all. Since investing can be done for very little cost today, investors should be thoughtful about what they are paying for and whether those costs are providing real value.
Investors should also watch for other fees such as loads, which are commissions attached to some mutual funds. These costs can be charged when you buy, sell, or hold a fund and often provide little benefit to the investor. In many cases, low-cost no-load index funds offer a simpler and more effective approach. Keeping fees low remains one of the most reliable ways to improve long-term investment results.
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When investing, you need to pay attention to your costs. That includes not only any fees you might pay to an advisor, but the fees you pay for the investment in the first place. Those fees have to come out of your return. There is nowhere else for them to come from. So, if the pre-fee return is 10% and there's 2% in fees, that means your after-fee return is only 8%, and that makes a big difference over time. Just like compound interest works on your returns, it also works on your investment costs, so they're worth paying attention to, especially these days when investing can be nearly free, right?
If you function as your own investment manager, i.e. you don't have a financial advisor, you cut those fees out. Now, as long as you're doing things as well as a financial advisor would be, you're going to come out ahead by whatever fees you would have paid that financial advisor. Some people are paying 1% a year, so they get returns that are 1% a year better. Over the course of 30 years, that means you have about a third more money than you would otherwise, so the fees really matter.
Typical investment fees, such as for mutual funds, include an expense ratio. That's all the costs of running the fund divided by the assets in the fund. While the industry standard for that is about 1% a year, the truth is most low-cost, broadly diversified index funds, like those you would get from Vanguard, Fidelity, Schwab, BlackRock, or iShares, and companies like DFA and Avantis, typically charge dramatically less than that. In fact, often less than 0.3%, or 30 basis points. Many of them are less than five basis points, or 0.05%, like the Vanguard Total Stock Market Index Fund (ETF), which is currently charging 0.03%.
In fact, Fidelity's got a few index funds for which the expense ratio is literally 0%. Now, while there's not much difference between 0% and 0.03%, it's interesting to see them use that, presumably as some sort of a loss leader for the other places where they do make money. But the bottom line is you can invest in every stock in the world, every bond in the world, essentially for free these days. So you've really got to ask yourself, when you are paying fees, why?
As I mentioned, there are a lot of mutual funds out there that charge higher fees, higher expense ratios. It's not unusual to see an expense ratio of 0.5 or 0.6 or 1% or even more. They get away with that because people don't know that investing can be pretty much free, and they also think that they're getting a benefit for paying that money. They think the active manager is going to get them out of the market before it goes down, pick only the stocks that go up and get rid of the ones that are going down, or short the ones that are going down. But the data suggests they are not very good at doing that. It's very hard to beat the market long term, so you're better off just paying really low costs and matching the market.
In fact, the main reason why index funds beat actively managed mutual funds the vast majority of the time, in the long run, especially after tax, is a cost story. They just cost less. It isn't that the active managers can't beat the market, they just can't beat it by enough to pay for their own costs. And so you've got to pay attention to those fees.
Other fees you might see are called loads. These are commissions, and there are advisors—I put that in quotes—out there who give advice in exchange for selling you these commissioned investments, such as a loaded mutual fund. The load can be paid up front. It can be paid when you exit the fund. It can be paid all along as you go each year when you own the fund.
Those are called A loads and B loads and C loads, or A shares, B shares, and C shares. Pretty much what they don't tell you is that there are mutual funds that are no-load, that you don't have to pay that commission at all. Again, if you're going to places like Vanguard and Fidelity and Schwab and BlackRock and buying their very low-cost index funds, you can avoid those loads.
So pay attention to your fees. They do matter. Keep them as low as you reasonably can, and recognize that the only place those fees can come from is your investing return.
The White Coat Investor Podcast is for your entertainment and information only and should not be considered financial, legal, tax, or investment advice. Investing involves risk, including the possible loss of principal. You should consult the appropriate professional for specific advice relating to your situation.
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