Before I talk about investment fees, allow me to start with a story. July 4th has come and gone and so has some of the summer’s most lucrative sales. But, thanks to my wife’s diligent coupon-clipping, we scored a sweet 20 percent off coupon for Harbor Freight. Obviously, I used that coupon to pick up some tools for our never-ending list of home improvement projects.
But, why the sale? Harbor Freight hosted this sale to get new customers in the door, and their strategy worked. If someone offers me 20 percent off something I need to buy anyway, I normally jump at the chance!
Holiday sales aside, what if I told you it was possible to get a much better deal on something else you need? To heck with 20 percent off. How about 95 percent off?
No matter the industry, a 95 percent discount is pretty much unheard of. Perhaps you could find discounts that steep at a going-out-of-business sale, but even those are rare.
The thing is, I actually do have a strategy that can help you save 95 percent on something even more important than home improvement supplies – your future.
Yep, I’m talking about the world of investing – a world where you can get plenty of discounts if you know where to look.
Investing Means Paying Investment Fees
Before I talk about how to save money and score deep discounts in the world of investing, I want to clarify the many ways you actually spend money on investing. Unfortunately, there are just as many ways to spend as there are to save.
If you’re buying an investment from a broker, chances are good you’re buying something that has a sales fee – also known as a load. Any investment with a sales load is terrible and you should run for the hills any time you encounter one. No matter what anyone says, there’s no reason to pay a sales load on anything, for any reason, ever. If someone tells you otherwise, it’s probably because they are not a fiduciary – someone who has your best interest in mind.
If you are a do-it-yourself investor, you may have to pay a trading fee. This could mean paying $3.95 to buy an ETF, or $30 to buy a mutual fund. But, you don’t have to pay this. Many brokerage firms give you access to their own funds (and sometimes other funds) without a trade fee. One example of this is Vanguard. If you use Vanguard, you can buy Vanguard funds without a trade fee. The same goes for Charles Schwab and Fidelity. You can usually avoid trade fees with any of these firms as long as you use their funds.
If your goal is saving money, don’t go to Charles Schwab to buy a Vanguard fund – or vice-versa. Go straight to the source, and you can potentially save considerable sums of money over time.
A bid/ask spread is another cost in the investing world. When you buy a security, you need to buy it at a high enough price to make it worth someone’s while to sell it to you. The extra money you pay is called the spread. You can avoid directly paying a spread when you invest using a mutual fund, although the mutual fund manager will have to pay the bid/ask spread themselves. Hopefully, the mutual fund manager knows enough to pay the lowest spread possible. Still, that’s never guaranteed.
With an ETF, you have to pay this spread fee twice. You’ll pay this cost when you buy the ETF, then pay it a second time when the ETF manager buys the investments that make up the ETF. When you buy a stock, you have to pay a trade fee and the bid/ask spread.
Want to save money? Purchasing a low-cost mutual fund directly from the company that issues it is one of the best-known ways to avoid all these fees.
This brings us to yet another way investing costs money – and the chance to save 95 percent on your investments.
Expense ratios are an ongoing fee you pay to use a fund to invest. Keep in mind, the fund can be a mutual fund or an exchange-traded fund (ETF).) Also keep in mind that expense ratios are expressed as a percentage (e.g. one percent). Let’s use an example to illustrate how expense ratios work.
Jim invests $100 in a stock fund. The fund charges a one (1) percent expense ratio. Assuming that the stock market returns nothing for an entire year, Jim’s investment is now worth $99.
Expense ratios vary wildly. They can be as little 0.02 percent (e.g. $0.02 out of every $100) to 3 percent ($3 out of every $100). All else being equal, a low expense ratio is better. A lower expense ratio means you’ll pay fewer fees and keep more of your money for yourself.
A Case Study in Expense Ratios, or How to Save 95 Percent When You Invest
Recently, a client with a sizable position in a Horse & Buggy Co. mutual fund visited my office. (Of course, there is no such thing as Horse & Buggy Co., but I’m sure you can figure out which company I’m talking about.) As expected with Horse & Buggy Co. products, this particular mutual fund was a complete rip-off. I say that because it had an expense ratio of 2.29 percent, which is fairly normal for Horse & Buggy Co. This kind of expense ratio is completely unnecessary, especially when you consider the fact you can find many, many solid funds at one-twentieth of the price.
To add insult to injury, the Horse & Buggy Co. mutual fund had been given the title “Horse & Buggy Co. MoneyGrower Equity” fund. I couldn’t make this up if I tried. What a joke! How can you grow your money when the fees you’re paying are practically extortion?
So, what happens when you move a client from a Horse & Buggy Co. mutual fund charging 2.29 percent into a low-cost diversified portfolio with an aggregate expense ratio of 0.10 percent?
You guessed it; you can save that client 95 percent on fees each year!
The Bottom Line
While you may never save 95 percent on your home improvement project, I hope I’ve illustrated how it’s possible to save 95 percent on certain investing fees with some creative thinking and thoughtful planning.
If your goal is getting the best return on your investments you can, make sure you’re looking out for fees and finding ways to avoid them.