Investment expenses come in a variety of forms and all have one thing in common: they reduce rates of return. The higher the expenses of a particular investment the lower the returns will be.

Common types of investment expenses are:

  • Expense Ratios
  • Transaction costs
  • 12b1 Fees
  • Account Fees

An Expense Ratio is a fee which is deducted from an investment to cover its costs. For instance a traditional mutual fund buys and sells securities within the fund, pays for managers, employees, marketing, technology, etc. An index fund will still buy and sell securities within the fund although its expenses are usually much lower than other types of funds. The expense ratio is an annual percentage and can range from 7 basis points (0.07%) for large efficient index funds to over 600 basis points (6%) for some hedge funds. This fee is seamlessly deducted from the overall value of the fund on a regular basis and is kept by the fund company.

Transaction costs are fees paid to buy or sell securities within an investment account. Transaction costs will vary depending on where you do your investing, what you invest in, and how often securities are bought and sold. Traditional broker/dealers will typically add large commissions to their transaction costs making buying or selling very expensive. Fee-only investment advisory firms do not collect any portion of transaction costs, which are charged by the custodian and typically low.

12b1 Fees are actually considered a load or a commission within the investment industry. These fees are included as a subsection of a mutual fund’s expense ratio. An advisor employed by a traditional broker/dealer will collect this fee as compensation. A fee-only advisor will typically avoid mutual funds with 12b1 fees however if one does exist, it is never received by the advisor.

Account Fees are charged by a custodian or broker/dealer to hold an account. Account fees, commonly called account maintenance fees, are usually charged as a flat annual or quarterly fee just for having the account open. Account fees at traditional broker/dealers can range from $40/year to $100+/year per account. Accounts held at large discount firms such as Charles Schwab have no account fees for any account type, with one uncommon exception.