Today begins a two-part series on fees.  If you have an investment account, you’re paying fees and how much may surprise you.  Learn what fees you’re paying, who you’re paying them to, and how you might be able to save some money.

The fees you pay directly reduce the amount of money you keep.  This is not news and in Part II of our series on fees, we’ll discuss how much impact fees can have on your investment accounts.  What I think is less apparent is that you are very likely paying fees without realizing it.  Let’s start our series on fees by identifying the common ways you’re charged to invest and receive financial planning advice.

Account Fees

Brokerage firms charge fees to their clients for maintaining and transacting within individual investment accounts.  These fees are typically flat dollar amounts and they tend to be assessed annually or when you transact.  The type and range of these fees include:

• Maintenance Fee ($25 – $125 per year)
• Account Close-Out Fee ($50 – $150 per account)
• Margin Fee ($25 – $100 per margin call)
• Stop-Payment Fee ($25 – $50 per transaction)
• Wire Fee ($15 – $50 per transaction)

Most of these fees can be avoided by setting up online access and transacting in your account without the assistance of the broker.  You may also avoid some of these fees by agreeing to receive statements and correspondences electronically.

Commissions

Commissions are fees that are paid when buying and selling shares of securities.  The more often you trade, the more you are likely to spend on commissions.  For years, the cost of trading stocks and bonds included a commission charge that could be as high as $100 per trade, but these fees have been in decline for years and have almost been completely eliminated for certain securities.  Robinhood was the pioneer of commission-free trading and most major brokers like Charles Schwab, TD Ameritrade, Merrill Lynch, and E*TRADE have followed suit.  The fine print is that most of the commission-free trading offered by brokers is limited to stocks and ETFs that are listed on major U.S. exchanges.  Trading in securities only listed on international exchanges, in mutual funds, bonds, and option contracts through a broker still often results in a commission charge.

To minimize commissions, reduce the frequency of your trading.  To avoid commissions entirely, find brokers who offer commission-free trading and limit your transactions to the securities that qualify for this benefit.  If you wish to trade mutual funds, look for non-transaction fee funds (NTF) or choose to invest directly through a mutual fund company.  The funds that are commission-free will likely be limited to those offered by the fund company itself and the expense ratio of the fund may be higher too.

Loads

Trading in certain funds can result in fees known as loads when you buy and sell shares.  Loads are really just another form of commissions.  The funds charging these fees are known as “load funds” and they typically offer different share classes of the same fund, where each share class has its own commission structure and expense ratio (more on expense ratios later).

Front-end sales charges (a.k.a. front-end loads) are assessed when you buy shares in a mutual fund.  FINRA limits these charges to 8.50% of the amount you invest and the rate declines as you have more invested with the fund company.  Here is the math: If you invest $10,000 in a load fund charging an 8.50% front-end sales charge, your broker will collect $850 in fees upfront and the remaining $9,150 will be invested in the fund itself.  Conversely, back-end sales charges (a.k.a. back-end loads) are assessed when you sell shares in a fund.  This charge is a percentage of your sale amount and is usually 1.00%.  Selling $10,000 in a load fund charging a 1.00% back-end sales charge will result in a $100 fee being paid to your broker and you’ll receive the remaining $9,900.

To reduce loads, invest larger amounts to hit breakpoints and use rights of accumulation if you plan to invest more over a period of time.  If you want to invest in mutual funds through a broker and avoid paying loads, NTF funds are your best bet, but they tend to be limited and they can have higher expense ratios.  An alternative to buying through a broker is to buy shares directly through a mutual fund company.

Expense Ratios

These fees are recurring and are assessed as a percentage of the amount of money you have invested.  They are specific to mutual funds and ETFs.  Stocks and bonds do not charge expense ratios.  This charge can vary significantly based on a number of factors, including but not limited to the: fund family, fund type, share class, and investment objective.  The primary factor that determines a fund’s expense ratio is whether it is passively or actively managed.  Passive funds charge lower rates because they are simply trying to hold all of the investment options held in the underlying index the fund tracks.  Actively managed funds charge higher rates because the manager is attempting to outperform its benchmark index by choosing between different investment options.

Expense ratios are outlined in a fund’s prospectus.  They tend to range between 0.04% to 2.50% per year.  If you have $10,000 invested in a fund with a 0.75% expense ratio, you’ll pay $75 per year.  If your balance grows to $100,000 in the same fund, you’ll pay $750 per year.  These charges are paid directly from your investment.

You can minimize the fees you pay via expense ratios by selecting passively managed investments like index funds and ETFs.  You can eliminate them altogether by investing in individual stocks and bonds.

Administrative Fees

Plan administrators develop, create, and administer retirement plans for the companies that hire them.  These administrators charge fees for keeping records, ensuring that the plan complies with the laws and regulations that govern them, overseeing the transactions in the plan, and communicating changes to company employees.  These fees are normally assessed as a percentage of the total amount invested in the company plan, and it is not unusual for employers to pass the fees on to their employees.  You can obtain information about the fees you are charged through a document called the Summary Fee Disclosure.

According to Brightscope, a leading evaluator of both fees and investment options for employer retirement plans, administrative fees usually range between 0.50% and 1.50% per year.  This is equivalent to a charge of between $500 and $1,500 per year for each $100,000 you have invested.  Unsurprisingly, company plans with lower total invested amounts tend to pay higher rates than company plans with more.

Since these fees are negotiated by your employer, you have little control over how they impact your retirement account.  You can advocate for changes through your company or choose not to invest in the plan at all.  Because administrative fees can be substantial, evaluating your plan’s cost is a good exercise, especially when trying to decide what to do with your account when you change jobs or retire.

Advisory Fees

Financial advisors charge advisory fees for their services.  These fees tend to fall under two distinct categories: investment management and financial planning.  A blend of these services and the fees that advisors charge for them is not uncommon, but many advisors specialize in either one or the other.

Investment management fees are primarily paid to financial advisors to research, select, and manage investment accounts on behalf of their clients.  These fees are recurring and typically charged as a percentage of the money that is invested.  According to research from Bob Veres, a San Diego-based financial planning columnist, the median investment management fee charged by advisors in the U.S. is 1.00% per year on the first $1.0M invested.  Under this fee structure, a client would pay $1,000 for every $100,000 they ask an advisor to manage.  A client with a $1.0M portfolio would pay $10,000 per year.

Financial planning fees on the other hand are paid for services related to budgeting, debt analysis, retirement planning, risk management, taxes, and estate planning.  The fees charged for financial planning tend to be a fixed amount and are determined based on the needs of the client.  Planning fees tend to range from $150 to $500 per hour for one-time engagements and $1,500 to $10,000 per year for ongoing planning and advice.   The specific services and fees a financial advisor charges are outlined in a document called the ADV Brochure.  The law requires that advisors provide a copy of this document before or at the time you sign on as a client and that you receive a new copy of the document each year or anytime the advisor makes a material change in their business.

To minimize advisory fees, ask the advisor how they are compensated for their service.  Many fee-only financial advisors charge flat fees for financial planning and have declining rates as you invest more money with their firm.  If you’re comfortable researching, selecting, and managing your investment accounts yourself, management fees can be avoided entirely.  The same is true if you are comfortable doing your own financial planning.