Ask a physician about his malpractice insurance premium and he’ll tell you that number down to the penny (and with disgust). Ask a physician about what fees he is paying in his investment portfolio and he’ll probably say, “I don’t know” (and expressionless). My job in the next few months is to stir up some disgust about investment fees.
If you trade individual stocks you’ll generally pay a fee to the brokerage firm for executing the order. The good news is that commissions have come down dramatically over the past decade due to online execution. Generally, trades will cost less than $20 and some deep discount firms offer trades for $7 or less. While commissions may seem cheap, remember that the commission is relative to the dollar amount of the order. So if you place an order to buy $500 of Microsoft with a $20 commission, you’ll actually end up with $480 of Microsoft. This translates into a 4% commission, which is quite high. You should think of this as a 4% loss right up front. The higher the dollar amount of the order, the lower the commission as a percent of the order. The same $20 commission on a $10,000 order results in a commission percentage of just 0.20%. With frequent small dollar trades, commissions can really add up to a substantial percentage of your portfolio. Further, when you sell you have to pay another commission. This is one reason why short term trading is hazardous to your wealth.
If you’re committed to buying individual stocks, you may also want to look into a DRIP (Dividend Reinvestment Plan). In a DRIP you can purchase shares of a company directly from the company for a very low or no fee. When the company distributes dividends (cash from profits), those dividends are automatically reinvested in the same company’s stock with no commissions. You generally don’t get to decide the exact time to buy the stock or reinvest dividends. Usually the very large companies offer DRIPs. An alternative to a DRIP is to find a brokerage firm which reinvests dividends without incurring a commission.
With mutual funds you’ll most likely pay a commission also. But there is a way around this in some cases. If you open accounts with a mutual fund company directly, you will generally not be charged any commissions if you buy that particular company’s funds directly. Over time this setup can save you hundreds or thousands of dollars every year. It also allows you to make small purchases without worrying about paying a high percent to commissions. When you sell a mutual fund, be sure to check whether there is a redemption fee. This fee is usually incurred when you buy and sell a fund within a short time period (usually 2 months) but can be as long as one year or more. While funds do this to encourage long term investing, if you’re simply selling just to reallocate your portfolio, then the redemption fee can make it difficult for you to do this. Another possible way around fund commissions is to do what is called an exchange. In this transaction you sell a specific fund from one mutual fund company and simultaneously buy another fund from the same mutual fund company. A lot of companies won’t charge you the selling commission in this case.
It seems like when you buy an airline ticket there are more nonsense fees added on every year–from airport surcharges to baggage fees to drink fees now. One popular brokerage firm charges all of the following fees: annual account administration fee, broker assisted trading charge, wire transfer fee, foreign securities transaction fee, and miscellaneous check fees (if you use the account for banking purposes). One way to avoid pesky fees like these is to consolidate all your accounts with one brokerage firm. Most firms will waive most or all of these fees by doing this.
Unlike an EP’s services, which are generally billed and collected at some standard rate dictated by third parties, financial advisor fees vary widely. Advisor fees fall into one of several categories: commissions, fixed fees (by the hour or by project), a percent of assets being managed, or a combination of the above. It’s important to know exactly what services are being offered: investment management only, financial planning, or both. Also, you’ll want to know whether the advisor is selling a product to you or selling only advice. In the case of advisor fees, what matters more is not necessarily the fee itself, but the value that the advisor adds to you. If your advisor is picking stocks, using market timing techniques, or searching for a money manager whom he thinks can beat the market, then you’re wasting your money. You may as well throw darts at the Wall Street Journal and pick stocks yourself or let the roulette wheel do it for you. An advisor should be familiar with the academic evidence of investing and incorporate your investments into the other areas of your financial life, such as tax planning and retirement planning. The impact of investment decisions to your overall financial plan is more important than the particular investments used. Also, while excessive advisor fees detract from your returns, fees which are too low also detract from performance because your advisor will have to take on a larger number of clients and won’t be able to spend the necessary time with you to stick with your plan.