Paying Fees On Your Investments

Most recently, I wrote an article highlighting some of my research showing that mutual fund fees do matter in investing.  Mutual fund fees are only one type of fee that impact investors returns.  In this article I would like to highlight some of the different types of fees that every investor should be aware of.

Mutual Fund Fees

When buying mutual funds, there are three key types of fees to be aware of:

1.    Management Expense Ratios (MER) – Lot has been written on management expense ratios.  They are one of the primary fees to be aware of when investing in a mutual fund.  The Management Expense Ratio measures all of the fees and expenses associated with the fund.  One of the expenses wrapped into the MER is the ‘trailer fee’ that goes to the financial advisor or broker as part of their ingoing compensation.

2.    Front End Load – In Canada, front-end loads are completely negotiable. In many cases you can pay as little as nothing to as high as 5%. This fee comes right off your investment. For example, if you are investing $10,000 and you pay a front-end fee of 2%, you will pay $200 for the purchase and $9800 will get invested. Paying a front-end fee means you have less money at work.

3.    Back End Load or Deferred Sales Charge – A back end load is different in that you do not have to pay anything up front. In the same example, you will have $10,000 invested and put to work. However, the mutual fund company has hooked you into a 6, 7 or 8 year time frame where if you leave their company before a certain time, you will have to pay a penalty for leaving early. The longer you stay with the fund company, the smaller the fee. Typically, you can still move your funds around within the same company without triggering fees. The theory is that back end loads promote long-term thinking.

A significant part of the front and/or back end loads go to the financial advisor or broker for compensation.  Do it yourself investors also need to be careful.  I’ve seen some investors who have bought mutual funds in their discount brokerage accounts choose the wrong versions of a mutual fund, where they buy a back end load fund instead of choosing the no load option or the front end load option.

Other Fees

Discretionary Fees – On some larger investment portfolios, financial advisors or brokers will promote the merits of a discretionary account.  This annual fee is similar to a MER but it is negotiable depending on account size.  This fee can also be potentially tax deductible on non-RRSP accounts.  The investment industry is a scalable industry which means the more money you have to invest, the more you can negotiate the fees.  Discretionary fees typically range between 1% and 1.5%.  The big thing to be careful of is to watch the fees on the investments in the account.  If you hold a mutual fund inside a discretionary account, you will be paying 2 sets of fees.  Especially watch for double dipping where the broker is making money from the discretionary fee as well as the fees off the underlying investments inside the portfolio.

Self-Directed Fee – This fee only applies to RRSPs and is typically charged by the administrating financial institution.  Self-Directed RRSPs allow investors to invest in a myriad of investments not restricted by the investments offered by one single company.

Trading Fees – Trading fees refer to the cost to buy and sell specific investments and/or securities within an investment account.  Typically full service brokers will charge higher trading fees than discount brokers.  If you are paying discretionary fees, you should not be paying trading costs.  Watch how your trading fees affect smaller purchases.  For example paying a $50 fee to buy a $1000 worth of stock is really a 5% fee.  It might be more economical to buy no load mutual funds on smaller purchases.

There can be other fees like account closing fees, administrative fees, withdrawal fees, etc. Fees will differ from institution to institution so it is important that investors be aware!  Know how much you are paying in fees.  Never be afraid to ask what the fees are and how institutions and advisors get paid.

Written by Jim Yih

Jim Yih is a Fee Only Advisor, Best Selling Author, and Financial Speaker on wealth, retirement and personal finance. Currently, Jim specializes in putting Financial Education programs into the workplace. For more information you can follow him on Twitter @JimYih or visit his other websites Retire Happy Blog, Group Benefits Online and Advisor Think Box.

11 Responses to Paying Fees On Your Investments

  1. James says:

    i would recommend to avoid any type of load fees front in or back end. most of the time you will have some sort of fee associated with the purchase and sale of the investment and to pay on top of that in my mind is silly.

  2. It is as bad as the phone company with all their nickel and dime tactics. Sad thing is, I would be probably see more value and be willing to pay more if they would make it easier and more transparent.

  3. Craig Ford says:

    I do think we can get too overfocused on fees instead of returns. I would be happy to pay 2% fees if I got a 12% return. That does make more sense than only paying .05% and getting a 8% return. There is something to be said for focusing on returns not just fees.

    • Tom Drake says:

      Craig,

      I tend to look at it the other way… using your example, paying 2% is a handicap of 1.5% without any guarantee of getting a better return. Unfortunately high fees do not equal high returns.

  4. Jim Yih says:

    Thanks for the comment:

    Fees are an economic reality and cannot be completely avoided. In my travels too many people have no clue what they are paying in fees and that is scary because no one cares about your money more than you.

    @Craig, I agree with your point. I’ve always said seek value which is your benefit less cost. The point I make is know your cost so you can relate it back to value.

    Lastly, as in my article Mutual Fund Fees do Matter (http://tinyurl.com/24bns3p) fees do have an impact on returns which is why people need to be aware of fees.

  5. Alex says:

    @Jim
    an even better study was just published recently http://advisor.morningstar.com/articles/article.asp?docId=20016
    although I’m sure you are aware.

    I’d also though that for some types of investments it may be worth accepting a high fees if you’ve done your research and those are justified. It’s just way too often people don’t spend even 10 minutes looking at a mutual fund, making their judgment based on assumptions and how popular the fund is. A bit of a vicious cycle.

  6. Seth says:

    I like the idea of a back end load for both parties. Investing really is a long term activity and thinking too short term usually leads to problems for the typical investor. Though something does bother me when banks and investment firms rake in billions in profits and then charge their customers who really need the money.

  7. Joe says:

    @Craig Ford The problems with paying fees upfront is that there is no return guarantees. While anyone would be happy to pay 2% to get 12%, you don’t know what you will be getting. I think a sliding performance based payment would be a happy medium. May be you pay 10% of your earning and nothing if you loose money?

  8. LawLeaf says:

    I don’t mind paying a broker fee or advisement fee as long as the investment pays a handsome dividend. If I’m working with a broker that produces 10%-12% returns, I’m more than happy to pay the fee on the front or backside of the transaction. I do like the idea of a sliding scale. Perhaps pay a small fee upfront and if the investment pays, pay a fee on the back end.

  9. Settlement Quotes says:

    @Seth I agree with your assessment. If both parties are in it for the long term investment fees are less and both parties win at the end.

    @Lawleaf I think anyone would be happy with a broker providing dividends in the 10-12% range.

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