This article is reprinted by permission fromÂ NextAvenue.org.
All things considered, 2020 turned out to be a pretty good year for small investors in many mutual funds, exchange-traded funds (ETFs) and 401(k) plans. The S&P 500 SPX, +0.87% was up about 15% through mid-December; the Dow Jones Industrial Average DJIA, +0.68% has risen by nearly 6% and the S&P aggregate bond index returned 7%. But how did youÂ reallyÂ do?
By that, I mean: how did your investments do after subtract what you had to pay in fees for them?
Itâ€™s an important question.
The question many investors canâ€™t answer
And, as myÂ â€œFriends Talk Moneyâ€ podcastÂ hosts Terry Savage, Pam Krueger and I explained in our recent episode about investment returns and fees, itâ€™s a question many small investors have trouble answering because theyâ€™re unaware of the fees they pay.Â
Hereâ€™s what Bob Bloom, a retired radiologist in Marin County, Calif., told Krueger (co-host of public mediaâ€™s MoneyTrack and founder of Wealthramp.com) when she asked how his investments did in 2020: â€œWhat I normally do is just look at [my investment statements showing] what I have the previous month and now what I have the next month. And if itâ€™s showing â€˜up,â€™ Iâ€™m really happy with it. I donâ€™t know very much else about the workings of what Iâ€™m getting.â€
But, as David Sterman, a fee-only financial adviser with Huguenot Financial Planning in New Paltz, N.Y., told Krueger: the financial industry â€œhas always loved operating a little bit in the dark, keeping clients in the dark, because that creates a culture of dependency on those firms. Itâ€™s kind of a â€˜trust us, everythingâ€™s taken care of.’â€
However, Krueger said, â€œseeing whatâ€™s behind the curtain is critically important. Individuals who invest in these funds andÂ ETFsÂ need to know how much these funds are paying themselves.â€
How investment fees can add up
And sometimes, they also need to know how much their financial advisers and brokers are getting paid because, as clients, they own certain investments.
The amount taken out for fees can be stunningly high.
A recent Wall Street Journal article cited a new research study on a type of target-date fund (the kind that invests in other funds, known as â€œfunds of fundsâ€) that found these funds charged â€œan unnecessary 0.33 percentage point in 2017â€³ compared with similar ETFs. As a result, their investors were â€œout of pocket an extra $2.5 billion.â€
Savage, a nationally syndicated personal finance columnist and author of â€œThe Savage Truth on Money,â€ gave this true-story example: An investor put $100,000 into a growth-stock mutual fund 20 years ago and earned an average annual return of 8%, with dividends reinvested. Her account should have grown to be worth $411,580, based on that performance, Savage said. But due to the fees she paid, it gave her about $330,000.
â€œThat is the true impact of excessive costs over the years,â€ said Savage.
We â€œFriends Talk Moneyâ€ podcast hosts werenâ€™t saying that the mutual fund operators, brokers and advisers didnâ€™t deserve to get paid for their work. Just that their investors needed to knowÂ beforeÂ investing what the fees would be and whether they could instead purchase similar, alternative investments with lower fees.
How ETFs can save you money
Sterman said that the last 10 years or so have been the advent of much lower-cost ETFs. â€œAnd the opportunity for savings with these funds is why weâ€™re looking at saving $6,000, $7,000, $8,000 a year per client,â€ he said.
Itâ€™s also important, Savage noted, to understand that many mutual-fund companies sell investors what are known as different â€œclassesâ€ of the same funds, with varying fees. â€œThat is a big secret of mutual funds that most people donâ€™t know,â€ Savage said.
So, it pays to ask your financial adviser or the mutual-fund company whether thereâ€™s a different class of the fund youâ€™re considering that would charge you less.
Also, I noted on the podcast, certain types of mutual funds charge more than others because of the types of investments they hold and the way the funds are managed.
Why some mutual funds cost more than others
For instance, international-stock funds, typically, cost more than domestic-stock funds. AndÂ index fundsâ€”which buy and hold a diversified basket of stocks or bonds â€” generally have lower fees than what are known as actively managed funds, whose managers decide which stocks and bonds to buy and sell.
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Bottom line, said Krueger: â€œIt requires doing some research and asking a lot of questions. And it may sometimes require switching advisers to one whoâ€™s going to be upfront with you.â€
Read the prospectuses from your mutual fund and 401(k) providers to learn about the fees you pay.
As Savage said, those fees can really cut into what you ultimately earn from your investments.
â€œThat money taken out in fees doesnâ€™t get to grow in the fund,â€ she said. â€œSo, thereâ€™s a long-term huge impact of paying too much in fees.â€
Richard EisenbergÂ is the Senior Web Editor of the Money & Security and Work & Purpose channels of Next Avenue and Managing Editor for the site. He is the author of â€œHow to Avoid a Mid-Life Financial Crisisâ€ and has been a personal finance editor at Money, Yahoo, Good Housekeeping, and CBS Moneywatch.
This article is reprinted by permission fromÂ NextAvenue.org, Â© 2020 Twin Cities Public Television, Inc. All rights reserved.
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