Investment cost

What are investment costs?

Investment fees are fees charged for using financial products, such as broker fees, transaction fees, and fee ratios. Investment cost is one of the most important determinants of investment performance, and it is an issue that every investor should pay attention to.

Over time, minimizing costs tends to maximize performance. However, it is important not to let costs dominate your investment decision-making process.

Key points

  • Investment fees are fees charged for using financial products, such as broker fees, transaction fees, and fee ratios.
  • Investment cost is one of the most important determinants of investment performance, and it is an issue that every investor should pay attention to.
  • Although over time, minimizing expenses will often maximize performance, but it is important not to let expenses dominate your investment decision-making process.
  • Certain investment products themselves charge high fees, such as derivatives and other more esoteric assets.
  • Certain asset classes tend to have lower fees, such as index ETFs and bond funds.

Understand investment costs

When focusing on other important topics (such as asset allocation or securities selection), it is easy to forget about fees. However, in addition to overall market trends and individual stock picking ability, the level of fees paid is one of the most important determinants of performance.

The following figures assume that you contributed $3,000 to your retirement account in the first year. Every year, as your salary increases, your contributions will increase by $250. So in the second year, you contributed $3,250, in the third year you contributed $3,500, and in the fourth year you contributed $3,750.

You continue to gradually increase your contribution for the rest of your career (30 years) and get an annualized return of 8% from your diversified investment portfolio. Although you get a total return of 8%, your net return will be reduced by the fees you paid. The higher the cost, the lower the return you will actually receive.

The only difference in the investment plan in the table below is the level of expenses-everything else is the same. Look at the difference in the amount you end up receiving when you retire, depending on how much you pay each year:

Total return cost Net return No fee account value Account value including fees “Lost” amount Due to cost
8.00% 0.50% 7.50% 648,118.44 USD USD 596,477.60 ($51,640.84)
8.00% 0.75% 7.25% 648,118.44 USD USD 572,454.51 (US$75,663.93)
8.00% 1.00% 7.00% 648,118.44 USD 549,551.41 USD ($98,567.03)
8.00% 1.50% 6.50% 648,118.44 USD USD 506,887.81 ($141,230.63)
8.00% 2.00% 6.00% 648,118.44 USD 468,078.69 USD ($180,039.75)

Source: From piggy bank to investment portfolio

A common retirement goal is to be able to withdraw 3% to 5% of the investment portfolio each year during retirement. In the above scenario, if two people invest in a similar way throughout their careers, but one person pays 0.5% of the expenses and the other person pays 2%, then their annual income difference after retirement will exceed the annual income difference. 5,000 USD.

This means that a person’s monthly income will be reduced by $420, simply because they have paid too much for the investment portfolio during their work.

Example of investment costs

Although it is not always necessary to aim for the lowest possible fees in an investment portfolio, it is usually a good idea to choose a range of investments and investment providers. With this in mind, the matrix below shows some typical costs. (Note: The fees in the matrix below are indicative and are intended as a starting point for further research and analysis.)

Online broker Stock trading ($) Option transaction ($)
Broker 1 8.95 8.95 + 0.75 per contract
Broker 2 7.99-9.99 7.99-9.99 + 0.75 per contract
Broker 3 7.95 7.95 + 0.75 per contract
Broker 4 9.99 9.99 + 0.75 per contract
Broker 5 7.00 7.00 + 1.25 per contract
ETF Issuer X Issuer Y
Standard & Poor’s 500 Index 0.06% 0.09%
Small Cap Index 0.17% 0.28%
U.S. Bond Index 0.11% 0.24%
EAFE index 0.12% 0.35%
Emerging market stocks 0.22% 0.69%
commodity 0.75%
Mutual Fund
Standard & Poor’s 500 Index Fund 0.17%
U.S. stock average 1.13%
U.S. Small Cap Index Fund 0.31%
U.S. small-cap stocks average 1.40%
U.S. Bond Index Fund 0.22%
Medium-term bond average 0.94%
International Large-Cap Stocks Average Index 1.37%
Emerging market stock average 1.69%

Types of high-cost investments

Certain types of investment products themselves charge high fees. Generally speaking, the more esoteric the asset class, the higher the fees you will pay.

For example, frontier market mutual funds generally charge higher fees than U.S. large-cap equity funds, commodity ETFs generally charge higher fees than ETFs that track large international stock EAFE indexes, and purchases of corporate bonds from Brazil will charge higher fees than U.S. Treasury bonds .

Many derivatives may also charge high fees. Although standardized option contracts and futures contracts can charge reasonable and transparent fees, products such as equity-linked notes are notorious for their opaque and high-fee structure.

Low-cost investment type

Just as certain asset classes tend to charge high fees, some assets tend to charge low fees. Index products such as ETFs and index mutual funds generally offer relatively low fees and are therefore attractive to value-focused investors. There are often alternatives offered by multiple vendors to evaluate (for example, multiple S&P 500 index funds).

Fee-conscious investors should pay special attention to a special type of mutual fund: those that charge front-end fees, up to 5.5% of the investment amount.

Since the products are essentially the same, the level of fees is likely to be the main source of future return differentiation; therefore, it is indeed worthwhile to choose the lowest cost supplier for indexed products. Remember, generally speaking, the more mainstream the asset class, the lower the cost, and vice versa.

Investors who pay attention to fees should pay special attention to a particular type of mutual fund. Although mutual funds as a whole are not expensive in themselves, some of them have front-end load fees as high as 5.5% of the investment amount.

The initial blow to your principal makes it difficult for you to outperform the market in the future. Many financial professionals recommend never buying any mutual funds that charge high sales fees, because without it, there are usually similar alternatives.

Bottom line

If you do decide to buy a fund with front-end fees, make sure you thoroughly research the fund to make sure that you get enough value (in the form of expected future performance) in exchange for paying the fees.

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