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
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.