5 Ways You're Paying Too Much To Invest
August 03, 2012 | Filed Under » 401K, ETFs, Investing Basics, Investment, Mutual Funds, Retirement
According to Consumer Reports, a household with two median income earners will likely pay $155,000 in fees to service their 401(k). That's roughly three years of salary for an average worker and although it's reasonable to expect a person to be paid for their services, nobody wants to overpay. That might be what's happening in your investment accounts. How do you know if you're overpaying for your investments?
The truth is that it isn't easy to know. Since advisors don't print the costs of their service on a menu similar to a restaurant, sometimes you won't know until it's too late, but here are some common ways that expenses may be eating in to your gains.
SEE: 6 Problems With 401(k) Plans
Expense Ratio
If you own mutual funds , ETFs or closed-end funds in any of your accounts, you're paying for somebody (or a team of somebodies) to manage that investment vehicle. The job of that product is to make you money, but some cost you more than others. The expense ratio tells you what percentage of your investment is taken to administer the product.
Look for expense ratios that are as low as possible. Well below 1% is ideal, unless the product is significantly outpacing the market.
Loads
There are thousands of mutual funds on the market and although only a small percentage are offered to the investor in their 401(k), IRAs and regular brokerage accounts, you have access to most of these funds, along with many other investment products. Because of all the choices available to you, there's no reason to pay front-end or back-end load fees on your mutual funds. Look for no-load mutual funds or products outside of the mutual fund family to avoid these fees.
SEE: The Lowdown On No-Load Mutual Funds
Your Financial Advisor
Fee-only advisors are supposed to be more trustworthy than commission-based advisors, because they have less of a conflict of interest, but giving away 1.5% or 2% of your year's gains to your advisor is hard to swallow. This means that in order for you to break even relative to the rest of the market, your account has to earn the same rate of growth plus your advisor's fee. That may not seem so bad in years where the bull was running in the market, but when it has a particularly bad year, you still have to pay the fee.
Look for a fee only advisor that charges less than 1% of your total assets or somebody that charges by the service instead of an asset based fee.
SEE: Paying Your Investment Advisor - Fees Or Commissions?
Trading Costs
If you're a retail or part-time trader, you know that every time you trade a stock, bond, ETF, mutual fund or any other product, you have to pay a fee to buy and a fee to sell. On a $10,000 account, you could lose 1% of your gains in trading costs if you trade 142 times, assuming that a trade costs $7. That may seem like a lot of trading but over the course of a year, that's not a lot of activity for an active trader. Concentrate on more long-term holdings to keep trading costs lower, or open an account that allows for frequent trading at a flat annual or quarterly rate.
Taxes
Mismanage your investments and expect to have a hefty tax bill. If you hold your investment for less than a year, you'll pay short-term capital gains tax of 35%. If you hold an investment for longer than one year, you'll pay 15%. If you withdraw money from your 401(k) prior to age 59 1/2, you'll pay taxes on the gains plus a 10% penalty. You can control your tax bill by holding investments for at least a year and seeking the help of a financial planner for how to properly get paid from your retirement account in the most tax-efficient way.
The Bottom Line
Investing is expensive - sometimes more expensive than necessary. You can't control what the markets will do in the future, but you do have a reasonable amount of control over how much you pay to invest. Paying too much can add up to a lot of money over time. Focus on what you can control instead of what you can't.
