There are many different ways in which costs are charged to your investment portfolio. Many of these are hidden and are basically untraceable. Today we are going to discuss a few of the hidden costs, and a few of the transparent costs.
Costs you should know about
Management Fee/Commission
Whoever your investment advisor is is making a percentage of their money from your portfolio. This is necessary, but you need to make sure that the fee or commission you are being charged is not over the top. If your working through an advisor that works on Commissions, then he legally cannot charge you more than 8.5% as a shave off the top of any new money coming in. That is a big percentage. For example, if you transfer in just $10,000 to an advisor that works on Commissions, they could take $850 out of the $10,000 thus lowering the value to $9,150 right off the bat. Commissions are also dangerous because it makes the advisor more focused on the sale and initial transfer then he is on helping you ongoing. He gets almost all his money upfront. A management fee is a percentage charged each year as a much smaller percentage than commissions. If your manager is trying to actively trade, he will usually charge a higher fee. You will usually be charged just commissions or just a fee, not both.
Mutual Fund Loads
A lot of mutual funds come with loads. These are additional costs to you that are basically penalties. They can be for different reasons, but many times it is to keep you from switching out of the fund. They charge you if you move your money out before a certain time frame. Not all mutual charge a load, so make sure your funds do not have a load.
Hidden Costs
Trading Cost
One of the main hidden costs comes from the Bid Ask Spread. The Bid Ask Spread is the difference between the buy price and sell price of a stock. The guy on Wall Street who actually performs the trade gets paid the difference. There is a cost to you every single time a stock is bought or sold by a fund. If your mutual fund is being actively traded by a manager trying to beat the market, then more likely than not they are losing you money on the way. If you are invested in institutional funds, aka passively managed funds like with Matson Money, then the trading cost you pay is minimal.
Expense Ratio
The expense ratio is how the mutual fund company pays for their operational costs. Operating expenses are taken out of a mutual fund’s assets and in turn lower the return to the fund’s investors. Usually retail mutual funds that are popular due to advertising have very high expense ratio’s. This is another cost that comes to you in the form of a lower return. The actual amount that it is costing you is very hard to quantify. You want to invest in funds with very low expense ratios.
There are a few other costs involved as well, but are only for specific accounts and situations. These costs are not necessarily a bad thing as long as they are kept low, and reasonable. Even with these costs, investing in stocks is the greatest wealth creation tool on the planet. To limit you costs you need to avoid actively traded funds and managers, and invest in a diversified efficient portfolio.
By Jimmy Hancock
References
1.Bold, Adam. “4 Hidden Costs in Investing – US News.” US News RSS. US News and World Report, 8 Feb. 2011. Web. 22 Sept. 2014. <http://money.usnews.com/money/blogs/the-smarter-mutual-fund-investor/2011/02/08/4-hidden-costs-in-investing>.
2.”Expense Ratio Definition | Investopedia.” Investopedia. Investopedia US, n.d. Web. 24 Sept. 2014. <http://www.investopedia.com/terms/e/expenseratio.asp>.