When you ask people what they find confusing about investing, someone is going to bring up investing fees. In fact, first-time investors may be surprised to learn that they have to pay fees to invest.
What are they and how are they calculated? Am I better off managing my own investments to avoid paying fees? Won’t fees eat into my returns? How do I know if the fees I’m being charged are appropriate?
While we can’t speak for every investment manager, we can shed some light on how investment fees generally work.
What investing fees can I expect to pay?
The fees you pay are largely dependent on what you are invested in and whether or not you manage your investments yourself. Taking three of the most common types of investments, let’s look at the fees you should expect to pay if you are invested in stocks, mutual funds, or ETFs:
- Stocks: Typically, if you’re invested in individual stocks, you are charged a trading commission for each sale or purchase, and may be charged an account management fee as well, for the services provided by your broker (sometimes these account management fees are waived; it depends on the broker and the value of your account).
- Mutual funds: Fees for mutual funds include the management expense ratio (MER) and the trading expense ratio (TER). Usually they are embedded within the fund you are invested in—which just means that these fees are deducted before your net asset value and returns are calculated. The MER represents the cost of professional portfolio management and their operational expenses. The TER is a small fee that represents the cost of trading individual securities within the mutual fund.
- Exchange-traded funds (ETFs): Most ETFs include a small embedded MER and, depending on the account, they can be subject to separate account management fees as well.
In addition to the fees outlined above, some institutions tack on performance fees, deferred sales charges and commission.
- Performance fees can be calculated in several different ways, but basically, they are fees that reward investment managers for outperforming a certain benchmark.
- Deferred Sales Charges (DSCs) are fees associated with some mutual funds and exist to discourage and penalize investors for withdrawing funds within a specified time frame. These fees are slowly being phased out of the industry, but you may still come across firms that offer DSC mutual funds.
- Trading commissions are slightly different from fees. A trading commission is the amount a broker charges for performing a single transaction—buying or selling an investment on your behalf. If you are trading individual stocks or bonds, the trading commissions can add up over time which will detract from your overall return.
Why would I pay to have a managed portfolio rather than managing individual stocks and bonds myself?
In addition to industry knowledge and expertise, a professionally managed portfolio can bring consistency and objectivity to your investing strategy. While it can be tempting to buy and sell based on your emotional response to the market when you’re managing your own investments, a managed portfolio can help make sure you stick to your long-term plan.
Won’t paying investment fees mean that I make less money?
That’s a complicated question. It’s true that investing fees can add up over time, and it’s true that if someone else is managing your portfolio, you’re going to pay more fees than if you managed it on your own. However, when you pay investment fees you are also paying for the comfort that a professional is applying their skills and experience to your investment plans, through the good times and the bad.
How do I know if I’m being charged too much?
There are two ways to get some perspective on whether or not the investing fees you’re paying are reasonable.
First, shop around. Ask other brokers and/or investment managers what their fees and rates are. If the fees you’re paying are consistently higher than the quotes you’re receiving, it may be time to take your business elsewhere.
Second, do some simple math. Typically, when you look at your investment statement, the returns are net of fees (the fees have already been subtracted). For example, if your portfolio return was 3% in one year and you know your annual fee is 2%, you can see that before fees your portfolio would have made 5%. Typically, it’s best to assess performance and fees over the long-term, but this example illustrates how fees can reduce returns over time. As an investor, you need to be sure that you are being compensated for the risk you are assuming and that your earnings are not being impacted by excessive fees.
If you think your fees are significantly reducing your investment earnings, consider asking your advisor how your fees are calculated and how they are compensated, or consider adjusting your investment strategy.
For more information about how investing fees (and bonuses!) work when you invest in mutual funds with ATB Wealth, check out our article on investing with ATB Prosper.
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