The kinds of fees
The SEC's investor bulletin sorts ongoing costs into a few groups:
- Annual fund operating expenses. A mutual fund or ETF is run by professionals, and the SEC explains that the costs of managing and marketing it are passed on to investors as fees deducted from the fund's assets: management fees, 12b-1 distribution or service fees, and other expenses such as legal and accounting. Their total as a percentage of average net assets is the expense ratio, which the prospectus lists as total annual fund operating expenses.
- Investment advisory fees. An adviser who manages the portfolio may charge an ongoing annual fee based on its value, on top of the funds' own expense ratios.
- Shareholder fees. The SEC's fee table lists sales loads, charged on purchase or on sale and similar to a broker's commission, plus redemption, exchange, account and purchase fees.
- Plan and product fees. The costs of running a 401(k) plan may be passed to participants, and a variable annuity adds its own administration charges, in each case on top of the underlying funds.
Where to find them
Every fund prospectus carries a standardised fee table, required by the SEC. The first block, shareholder fees, shows the loads and transaction charges. The second, annual fund operating expenses, shows management fees, 12b-1 fees, other expenses and the total, each as a percentage of the fund's average net assets. That total is the number to compare between funds. The SEC also points investors to FINRA's Fund Analyzer for side-by-side comparisons. For an adviser, the fee schedule is in the account agreement.
The SEC's example
The bulletin's chart takes $100,000 invested for 20 years at a 4 percent annual return and applies three ongoing fees. Recomputed here year by year, the fee simply reducing the return:
| Annual fee | Net return | Value after 20 years | Less than the 0.25% case |
|---|---|---|---|
| 0.25% | 3.75% | $208,815 | — |
| 0.5% | 3.50% | $198,979 | $9,836 |
| 1% | 3.00% | $180,611 | $28,204 |
The SEC's own summary of that chart: fees that seem small can have a major impact on a portfolio over time, and the 1 percent fee leaves the investor nearly US$30,000 poorer than the 0.25 percent fee after 20 years. The compound interest calculator reproduces any of these rows: enter the return minus the fee as the rate.
Over a working life
The same arithmetic over 30 years at 7 percent, with fees from an index-fund level to an adviser plus actively managed funds:
| Annual fee | Value of $100,000 after 30 years | Paid away in fees and lost growth | Share of the gain lost |
|---|---|---|---|
| 0.05% | $750,626 | $0 | 0% |
| 0.5% | $661,437 | $89,189 | 14% |
| 1% | $574,349 | $176,277 | 27% |
| 2% | $432,194 | $318,432 | 49% |
The last column is the point. A 1 percent fee does not cost 1 percent of the money; over three decades it costs roughly a quarter of the growth, because every dollar taken in fees stops compounding too. The rule of 72 shows the same thing from the other side: at 7 percent money doubles about every 10 years, at 6 percent every 12.
Value after n years = start × (1 + return − fee)ⁿ
Keeping fees down
- Read the total annual fund operating expenses line before anything else about a fund. Index funds tracking the same index are interchangeable except for this number.
- Add up the layers. An advisory fee plus the funds' expense ratios plus plan costs is the real figure; each is quoted separately.
- Avoid loads. A sales load is a fee paid before the money is even invested.
- Measure returns net of fees. The ROI calculator works from what you put in and what you got back, which is after costs; the dividend calculator shows income growth that fees quietly reduce.
- Check the 401(k) menu. The 401(k) calculator takes an annual return; lower it by the plan's total cost to see the real projection, and the retirement savings calculator does the same for the whole plan.
None of this says fees are never worth paying. It says that the price has to be known to be judged, and that over long periods the price is far larger than the percentage suggests.
Frequently asked questions
What is an expense ratio?
The SEC describes a fund's annual operating expenses, management fees, 12b-1 distribution or service fees and other expenses, as a percentage of the fund's assets: the expense ratio, shown in the prospectus fee table as total annual fund operating expenses. It is deducted from the fund's assets every year, so you never see a bill; it simply lowers the return.
How much does a 1 percent fee cost over time?
The SEC's example is US$100,000 earning 4 percent a year for 20 years. With a 0.25 percent annual fee the portfolio ends at about $208,815; with 1 percent, about $180,611. The SEC's conclusion: the 1 percent fee reduces the portfolio by nearly US$30,000 compared with the 0.25 percent fee.
Is a 1 percent fee a lot?
As a share of the return, yes. If a fund earns 7 percent before costs, a 1 percent fee takes a seventh of the gain every year, and in a 4 percent year it takes a quarter. The SEC's point is that fees which look small still compound against you, because the money paid in fees is also money that no longer earns the return.
Where do I find a fund's fees?
In the prospectus fee table, which the SEC requires in a standard format: shareholder fees such as sales loads, redemption and account fees, then annual fund operating expenses with the total as a percentage of average net assets. The SEC also names FINRA's Fund Analyzer as a tool for comparing fund costs.
Do 401(k) plans charge fees on top?
They can. The SEC notes that the expenses of operating and administering a 401(k) plan may be passed to participants, in addition to the operating expenses of the funds held in the plan, and that variable annuities add administration charges on top of the underlying funds.
Sources
- SEC Office of Investor Education and Advocacy: Investor Bulletin, How fees and expenses affect your investment portfolio (the US$100,000, 4 percent, 20-year chart with fees of 0.25, 0.50 and 1 percent; fees that seem small can have a major impact over time; advisory fees, annual operating expenses and the expense ratio; 401(k) and variable annuity fees)
- SEC Office of Investor Education and Advocacy: Investor Bulletin, Mutual fund fees and expenses (the prospectus fee table: shareholder fees and sales loads, management fees, 12b-1 fees, other expenses and total annual fund operating expenses as a percentage of average net assets; the 20-year chart)