Understanding Investment Fees
The last time I wrote a blog, the world was in a very different place. It would be remiss of me not to acknowledge what is going on right now. Most of us are relegated to shelter-in-place; worrying about our health and the health of our loved ones; and also thinking about our financial security right now. Moments like this bring home to me how important it is to be actively and continuously working on personal financial fitness. Not just so that we can have some measure of security for our own peace of minds, but also so that we can reach out and help others.
If you are in a financially stable place right now, I encourage you to look into ways you can help the community around you. Being able to bless others allows us to also be blessed down the road.
Regardless of where you are in your financial fitness journey, I encourage you to use this plethora of new-found free time to assess your finances and start working on goals you've laid out for yourself. This will better prepare you to hit the ground running once the world is back to normal (whatever that means).
Now on to regularly scheduled programming.
Welcome to the culmination of our three-part series on investing. You've made it! How was Mutual Fund Madness? Did you pick out some stellar mutual funds to invest in? Now is a great time to start doing this research; a good way to occupy your time while simultaneously preparing for the future. To aid you in this research, we are going to talk about the different fees that can apply with investing.
First, some general information on fees. Fees are charged to pay the planners, stockbrokers and managers of the assets you are investing in. The thinking is that these people are giving you sound advice so they are worth whatever the fee is. I'll let you be the determining factor on whether or not that is true. The amount of your fee is determined by the percentage of your investment. So if you invest $1,000 and the fee is 5% then you'd pay $50 in fees. You can find out what percentage of your investment goes to fees and what kind of fees you are paying in a chart in the prospectus of the asset you are investing in. Additionally, all mutual funds charge an "annual management fee." The amount of that fee can also be found in the mutual fund's prospectus. The fees we will discuss today are mainly relevant to mutual funds, but can also apply to other investment categories as well.
Second, there are two overarching types of fees in investing: no load, and load fees. Load fees are more common, so we'll address them first. While all fees are reported in the asset's prospectus, funds that utilize load fees (called load funds) do not automatically send out their prospectuses so you have to request them. The purpose of load fees are to reduce the volatility of an asset by discouraging investors from selling their shares too early. When people buy and sell quickly it is called short-swing trading and that can be potentially detrimental for the investor; hence the load fees to keep them in check.
Front-end load fees are charged when you purchase your share, and typically are taken out of the amount you wanted to invest. Therefore, the amount actually invested is reduced by the cost of the fee. Back-end load fees are only relevant to mutual funds, and are applied when you sell your share. Back-end load fees are typically applied if you sell your share within the first 3-5 years of owning the share. The purpose of which is to keep investors from selling out too early. Mutual funds are typically long-term investments and selling out early will reduce the benefit to the investor. Back-end load fees are either flat fees, or fees that decrease over time, especially after the first 3-5 years. The amount of these fees is calculated by a percentage of the profit you've made by selling the share. Both front-end and back-end load fees are lump sum payments.
No load fees are a little different. Unlike load fees, no load fee prospectuses are sent out automatically so there is no need to request them. Like load fees, these fees go to paying for the people managing your assets. The major difference is that no load fees are not applied at purchase or selling of a share, but rather annually in (typically) smaller amounts than load fees. These are called 12B-1 fees. This seems like a better solution; however, those smaller amounts charged annually can quickly become more than what you would have paid in load fees over time. Because there is no cost up front or on the back end, some people are sucked into investing in no load funds. Regardless of what you decide, make sure to compare what the fee cost will be over time.
The gif at the top of this blog is how we can feel when we are investing and "throwing away" money through fees. The truth is, fees are always going to be a part of an investor's life. But you can reduce the feeling of throwing money away by understanding what types of fees are out there and, over time, which fees will save you money in the end. Don't let the fact that you have to pay fees discourage you from investing. If you invest well, you'll make those fees back. Just try to be as knowledgeable as possible and you will be fine. Stay safe and healthy out there folks, and happy investing!