Why You Should Care About Hidden Mutual Fund Fees

I love surprises. I mean, who doesn’t love opening presents to see the gift inside? What fun! Now, there’s one area where I don’t like any surprises: my investments. Some investments that can surprise you with their fees are mutual funds—and that’s not fun.

Why This Confusion About Fees?

Mutual fund companies make money from the fees they charge investors. Some fees are hidden so deep in the paperwork that they’re almost impossible to spot. And every company uses different lingo, so it can get confusing easily. Fees usually fall under two major umbrellas: ongoing fees and transaction fees.

Ongoing Fees. These are sometimes called annual operating expenses. With almost 8,000 different funds in the mutual fund industry worldwide, these fees can differ a lot, but they usually pay for services like:

  • Managing the fund’s portfolio (keeping track of what you’re invested in)
  • Record keeping (tracking what you’ve bought or sold; sending correct information for filing taxes)
  • Marketing fees (also known as 12b-1 fees)
  • Customer service (telephone and web)

Mutual funds bundle their ongoing costs into one category called an expense ratio. In 2014, the average expense ratio across all types of funds (bonds, mutual funds, annuities) was 0.64%. That means for every $1,000 worth of mutual funds you own, you’ll pay $64 in ongoing fees for that year. As your account grows (or drops) in value, so does the expense ratio.

Some fees aren’t included in expense ratios, so watch out for those on your reports. If something looks fishy, ask about it. Don’t pay for something you don’t understand or don’t think you owe. Also, watch out for companies that charge fees quarterly. You may be paying a higher-than-average fee when added up for the year.

Transaction Fees. Unlike ongoing fees, transaction fees are one-time expenses you pay any time someone makes a change to your investments (buys or sells mutual fund shares). These costs are also called shareholder fees or individual expenses. Here are some common charges:

  • Commissions (or sales charges)
  • Redemption fees (when you sell shares in a fund)
  • Exchange fees (taking money out of one mutual fund and putting it in another)
  • Account service fees (if your account drops below a certain amount)

The more you buy, sell or change anything in your retirement account, the more fees you pay.

Why Should I Care About Fees?

If all of this information makes your head spin, you may be asking yourself, Why do I need to know this? Can’t we skip this part of retirement planning? After all, it’s only a matter of one percentage point, right? Wrong! The higher your fees, the less you accumulate in your retirement fund. Over time, that can be the difference between an average retirement and an amazing retirement.

Let’s say you’re 35 years old and have $25,000 invested in your 401(k). Let’s also say you average a 7% return on your investments in your account and put nothing more into that account until you retire. How much will you have at age 70? That depends on your fees.

If you paid 0.5% in fees every year, you’d end up with $227,000 at retirement. But if your fees were 1.5% per year, your retirement fund would drop to $163,000. That 1% difference in fees would reduce your retirement dream by 28%! When your money earns compound interest every year, that 1% makes a huge difference!

Let’s take another example to see this on a larger scale. Say you’re 30 years old when you start investing, you have $10,000 to open your account, and you add $10,000 every year. Look at the balances when two different expense ratios are used for 40 years:

Starting balance: $10,000                            Starting balance: $10,000

+ $10,000 added annually                             + $10,000 added annually

@ 6% yearly return (profit/year)                  @ 6% yearly return (profit/year)

– 1.25% expense ratio for 40 years           – 0.25% expense ratio for 40 years

= $1.2 million                                                      = $1.55 million

That’s a difference of $350,000! I don’t know about you, but I’d much rather have that extra money in my bank. That’s why you need to know how much you’re being charged in fees!

How Do I Figure This Out?

I tell my clients to talk to a professional when it comes to their investments. You don’t try to fix a broken foot on your own—you rely on a professional who has the education and experience. The same applies to investing. Get a great financial guru who can guide you through the murky waters of fees. And if they’re not willing to tell you their fees, get someone else.

Even if you have the best financial advisor in the business, don’t just hire him and hand over the reins to your retirement fund. Meet regularly. Ask questions—especially how much you’re being charged in fees. It’s your retirement, so it’s your responsibility. Nobody will care about it as much as you will.