Are you aware of ALL the fees you’re paying on your portfolio? Over time, even small fees can cannibalize the return of your portfolio. We have observed that most investors focus on just a few, not fully aware of how to maximize the true net return of their portfolio.

In this article, we will discuss the different types of investment fees and provide strategies to reduce or eliminate:

• Expense ratios

• Tax costs

• Cash drag

• Transaction fees

• Advisory fees

Expense Ratios

An expense ratio is a fee that is charged by a mutual fund or exchange-traded fund (ETF) to cover the costs of managing the fund. Expense ratios are typically expressed as a percentage of the fund's assets. For example, a fund with an expense ratio of 0.50% would charge $50 for every $10,000 invested in the fund.

Expense ratios can vary widely from fund to fund. Some funds have expense ratios of less than 0.10%, while others have expense ratios of more than 2.00%. The higher the expense ratio, the more it will cost you to own the fund.

Lower fees do not always translate to better net returns. Some investments may charge more because of specialized knowledge or research. It is important for investors to understand what they are paying, and what they are receiving in return.

Tax Costs

According to Morningstar, the average mutual fund has a tax cost of 1.0-1.2% of the total return. Meaning if a fund has a gross return of 10%, the investor will net ~9.0% after taxes – even if the investor never sold.

When you invest in stocks, bonds, or other securities, you may be subject to taxes on capital gains, dividends, interest, etc. Capital gains taxes are most common and are paid on the profits you make when you sell an investment. The amount of capital gains taxes you pay will depend on the length of time you held the investment and your income tax bracket.

The type of investment you choose can also affect your tax costs. For example, ETFs tend to be more tax efficient than mutual funds. This is because ETFs are passively managed, which means they do not trade as frequently as actively managed mutual funds. As a result, ETFs generate fewer capital gains distributions, which can help to reduce your tax bill.

Even if you don't sell your holdings in a mutual fund or index fund, that fund might still have taxable distributions. If enough investors in a fund sell and request a redemption, the fund manager might have to sell investments to raise enough cash to pay out exiting investors. Any realized gains from this transaction are passed along to all investors in the fund, even those that did not sell.

There are a few things you can do to minimize your tax costs when investing:

• Choose investments that are tax efficient. ETFs are a good option for taxable portfolios, as are individual stocks and exchange-traded notes (ETNs).

• Hold investments for the long term. If you hold a security for more than 365 days, you will not have to pay short-term capital gains taxes which are typically taxed at higher income rates.

• Utilize tax loss harvesting. By realizing losses an investor can offset current or future gains, reducing the total tax liability of the portfolio.

Cash Drag

Cash drag is an often-overlooked cost that occurs when a mutual fund or ETF holds a significant amount of cash. Cash drag can reduce your investment returns because cash earns a lower return than the investments in the fund. Investors should aim to invest in securities that are fully invested in the sectors/strategies they’re being employed for.

For example, let's say you invest $10,000 in a mutual fund that has a 10% cash position. The fund's investments earn an average annual return of 10%. However, because the fund holds 10% cash, your actual return will be 9%.

Transaction Fees

Transaction fees are fees that are charged when you buy or sell an investment. Transaction fees can vary depending on the type of investment and the brokerage firm you use. Modern technological advancements in trading have rendered transaction fees unnecessary; investors should be wary of any institution that charges fees for simple transactions.

For example, if you buy a stock through a traditional brokerage firm, you may be charged a commission of $10 or more. If you buy a stock through a discount brokerage firm, you may be charged a commission of $5 or less.

Advisory Fees

Advisory fees are fees that are charged by financial advisors for managing your investments. Advisory fees are typically expressed as a percentage of your assets under management. For example, an advisor who charges 1.00% per year would charge $1,000 per year to manage $100,000 in assets. Advisors often have tiered fee structures, meaning the more money they manage the lower the composite fee.

It is important to ask your financial advisor if they are simultaneously earning income from the sale of other investment/insurance products, such as commissions. Ensuring your financial advisor is incentivized to grow your portfolio, and not just earn a commission, is paramount to your financial success and a long-term trustworthy relationship.

Financial advisors that also focus on providing financial planning, tax strategies, estate planning, etc. can often cover their costs through reduced taxes and ensuring your financial plan on track for success. We recommend working with CERTIFIED FINANCIAL PLANNER™ professionals to help ensure these standards are being met.

How to Minimize Investment Fees

There are a few things you can do to minimize investment fees:

• Choose investments with low expense ratios. There are many low-cost mutual funds and ETFs available. You can find them by comparing costs on websites such as Morningstar.com.

• Invest for the long term to minimize the impact of capital gains taxes. The longer you invest, the less frequent the impact of taxes on your wealth accumulation.

• Avoid holding cash in your investments. Cash is a poor wealth accumulation tool.

• Avoid trading frequently. Every time you buy or sell an investment, you may be subjecting yourself to taxes and/or transaction fees.

• Consider working with a fee-only financial advisor. Fee-only financial advisors don’t receive commissions from selling financial products. This means they have no incentive to recommend high-fee investments, insurance, or annuities.

Conclusion

Investment fees can have a significant impact on your investment returns over time. By understanding the different types of investment fees and how to minimize them, you can improve your net investment returns.

 

DISCLOSURES:

The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.

The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.

Consilio Wealth Advisors, LLC (“CWA”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where CWA and its representatives are properly licensed or exempt from licensure.