The investment industry is in the midst of a price war that will cut costs for many — from individual investors to sophisticated hedge fund participants. That's great news for investors.
Individual investors have little concept of the impact of investment fees and costs on overall return. It can be huge. There are two types of fees, and they are not always fully disclosed or transparent.
Initial investment cost
The first big cost you might face is the initial cost of getting into the investment. These up-front commissions are often baked into the price you pay for the stock, bond or mutual fund and are not disclosed separately on the sales confirmation. If you invest $10,000 in a broker-sold mutual fund, it's likely that about $9,500 of that investment will go to work for you in the stock market. The rest goes into the broker's pocket. Those up-front costs diminish your investment returns dramatically.
Ongoing management fees
Whether you pay a fee for advice or the fee is part of the cost of research and commissions in a mutual fund, these annual charges have a huge impact on your long-term return. If you just hope to do as well as the market (a pretty good return over the long run), consider an index fund that tracks a popular index like the S&P 500. These funds have far lower costs because they do not have any stock research costs, and they only sell a stock when it is taken out of the index.
Vanguard's website shows the impact of annual fees on a $100,000 investment over 25 years.
If the account earned 6 percent a year for the next 25 years and had no costs or fees, it would ultimately be worth $430,000. But if you paid 2 percent a year in costs, after 25 years you would have only about $260,000.
In other words, paying that management fee every year would have wiped out about 40 percent of your total return. The fee impacts not only the money you have invested, but the returns that would have been compounding in your account every year if fees weren't subtracted.
There is already a price war going on in hedge funds, which are cutting fees dramatically in the wake of poor performance. Gone are the days of charging 2 percent annual fees and 20 percent of the profits.
Individual investors benefit from this fee price war, too. Fidelity just announced it is cutting its annual expense charges for its Fidelity 500 Stock Index (S&P 500 Index) and Total Market Index to a miniscule 0.045 percent annually. (And there's no up-front commission at Fidelity.)
Then, within a day of the Fidelity announcement, long-time index fund leader Vanguard dropped its annual fee on major index funds to 0.04 percent.
Daniel P. Wiener, editor of the Independent Adviser for Vanguard Investors (www.adviseronline.com), says the competition is intense because of the trend toward investing in “passive” funds that track the major indexes. In fact, in 2016 Vanguard reached $4 trillion in assets under management, mostly in index funds.
But Wiener also notes that just because a fund is called an “index fund” doesn't mean it has low fees. He points to some index funds inside 401(k) plans sold by insurers. Notably the State Farm S&P 500 Index Fund B has annual expenses of 1.38 percent. And the JPMorgan Equity Index A fund, which tracks the S&P 500, has annual expenses of 0.4 percent, plus a 5.25 percent upfront sales charge.
The moral of this story is that smart investors can save on fees and do as well as the market by purchasing low-cost index funds that track the market. That's The Savage Truth.
Terry Savage is a registered investment adviser and the author of four best-selling books, including “The Savage Truth on Money.” She responds to questions on her blog at TerrySavage.com.