Many investments come with fees. This is especially true if you select a mutual fund that is actively managed, which means you must pay a fund manager to individually select the stocks that your money is put into.
When you are deciding what to do with the assets in your brokerage account, you'll probably want to consider just how high the fees are on different investments you're thinking about putting your money into.
That's because investment fees can make a huge difference in the amount of money that you actually end up with -- especially if you are investing for a long-term goal such as saving for retirement.
Just how much do investment fees matter?
To understand how much investment fees can affect the amount of money you end up with, check out the table below. It shows what your balance would be if you invested $100 per month for 20 years, earned an average annual return of 10%, and paid differing fee amounts.
| 0.50% Fee | 1% Fee | 2% Fee |
|---|---|---|
| $68,242.07 | $64,345.89 | $57,265.93 |
Data source: Author's calculations.
As you can see, your account balance is more than $10,000 smaller as a result of the higher fees you'd get stuck with if you opted for a more expensive investment. And the more you invest, the longer you're invested for, and the higher the fees that you get hit with, the bigger the impact those costs will have on your final balance. This can affect the income your investments produce for you later on, and leave you with a smaller checking account balance that notably affects your standard of living.
See, when you pay fees, you end up lowering the effective returns you earn. You have less money to reinvest, so compound growth doesn't help you build wealth as quickly. That's why the impact is so dramatic when you're investing over the long term, even if the fee seems like a small one on paper.
How to avoid expensive investment fees
The good news is, it's pretty easy to avoid big investment fees. You just need to do a few things:
- Choose a brokerage firm that won't charge for your business. There are plenty of online discount brokers that do not charge you to open or maintain an account and that don't charge you inactivity fees or commissions for trading. Pick one of them.
- Pick passively managed investments. Actively managed investments rarely do as well as you might think. In fact, less than 7% of actively managed equity funds in the U.S. have actually managed to beat the stock market. Why would you pay someone to invest money for you when you could just buy an index fund that tracks the performance of the market as a whole and do better?
- Understand the expense ratio of investments you are considering. When you invest in a mutual fund or exchange-traded fund (ETF), the expenses are published. Check how much you'd pay for different investments and opt for lower-cost options. Your brokerage firm will often let you sort investments based on fees charged, so this process should be easy.
By taking these steps, you can avoid reducing the returns you earn and end up with a much larger portfolio balance over time.
