It’s all about fees. There are many fees that eat into your retirement nest egg. The most significant ones are the management fees charged by mutual funds (called “expense ratios”), advisory fees and commissions. Here are some hot tips for dealing with these fees.
Hot tip # 1: Require all fees to be expressed in dollars
Did you ever wonder why mutual funds and advisors express their fees as a percentage of assets? For example, an actively managed mutual fund might have an expense ratio of 1%. This is the cost of running the fund and typically includes administrative costs 12b-1 fees and other expenses.
By expressing the expense ratio as a percentage of assets, the actual cost is both minimized and trivialized. Who cares about 1%? But what if this expense was expressed in dollars? On an investment of $200,000, 1% is $2000. The dollar figure gets your attention. The percentage number doesn’t.
It gets worse.
Hot tip # 2: Use a compound calculator
A mutual fund (and an investment advisor) charges an annual fee. In the example above, you’ll be paying $2000 a year (and perhaps more or less depending on the value of your holdings). What impact does this fee have on your retirement savings? To find out, use a compound calculator.
Let’s assume that, instead of investing in an actively managed fund that charged an expense ratio of 1% annually, you invested in an index fund or exchange-traded fund with an expense ratio of only 0.15%. Your annual fee would only be $300 instead of $2000. Now let’s assume you invested the difference ($1700) and earned a modest return of 4% annually for 20 years. Here’s where the compound calculator comes in handy.
At the end of 20 years, your annual investment of $1700 would be worth $56,372.55.
That’s the kind of money that can make a big difference in achieving your retirement goals.
Hot tip # 3: Minimize mutual fund fees
Financial journalist and author Jonathan Clements wrote this wonderful blog post about the price war among major index fund providers. He shows you how to build a broadly diversified portfolio using just three index funds. Remarkably, you can do so using the lowest cost funds he identifies for a weighted average expense ratio of a puny 0.05% of your assets. In dollar terms, on a portfolio of $100,000, that’s just $50 bucks a year.
Hot tip # 4: Minimize advisor’s and broker’s fees
Most advisors express their fees as a percentage of assets under management. You now know to ask them to express their fees in dollars and to use a compound calculator to determine the impact of those fees.
The first question to ask yourself is whether you need any advisor or broker. Some investors are perfectly capable of investing on their own, following the recommendations in Clement’s blog or in my blog on investing on your own.
For some investors, only one index fund may be sufficient for your needs. I discuss low management funds that might be suitable in this blog.
If you need help, consider using a financial planner who doesn’t manage money or sell products and who charges a flat fee for preparing a financial plan. Many planners will help you implement a do-it-yourself investment strategy. Because they charge a flat, one-time fee (with optional fees for yearly reviews), these planners cost significantly less than most asset-based advisors. You can find a reliable list of qualified planners on the website of the Garrett Planning Network.
If you need assistance, you can get it from the new breed of robo-advisors. Some are fully automated. Large mutual fund families like Fidelity, Charles Schwab and Vanguard offer “hybrid” services that provide personal advice and automated investing. You can find helpful information about some of these providers here and on the websites of the fund families. All of these alternatives charge significantly less than a traditional full-service advisor.
A full-service advisor can offer significant value (over and above investing expertise) to higher net-worth investors and those with more complex financial issues. Even these advisors are feeling the pinch of new competitors. You may be able to negotiate their fees. It’s worth a try.
Hot tip #5: Shift your focus
Most investors focus on stock picking, market timing and selecting a “hot” mutual fund manager. Instead, shift your focus to building a low-management-fee, globally diversified portfolio of index funds, in an asset allocation suitable for you. Your new focus is on fees charged by advisors, brokers and mutual funds.
That’s my hot tip for a cool retirement.