Investors have more options than ever these days. Thousands of stocks, mutual funds and ETFs are available in hundreds of assets classes – some are specific (small cap domestic energy sector stocks, or large cap technology growth stocks) while some are broad (all US stocks or all global bonds).
While choosing the right asset mix is most important, choosing the right assets is a close second. Many mutual funds charge high fees – some charge sales fees as high as 5% – and they all charge an ongoing “management fee” of up to 2% each year. Most people consider funds with fees of over 1% to be expensive.
Now you might think 1% or 2% doesn’t seem like a lot of money. If you were buying a cup of coffee and were charged a 2% convenience fee, you might not care. But when it comes to investments, even a 1% fee can take a big cut of your return.
Stocks have returned about 10% annually over the last 80 years. After inflation, the real return has been about 7%.
Now consider paying 1% in fund fees on your investments earning 7%. That’s over 14% of your expected return each year (1/7 ~ 14%)! 1% doesn’t seem like a lot, but a 14% fee seems crazy. And that’s for a 1% fund in one year. A fund with a 5% sales fee could eat almost your entire return that year. And don’t even get me started about the impact of compounding that return.
Always remember to watch those fees!