If we save enough, start an investment account, and keep it growing for our entire life, the cost we incur to invest will be the largest service expense of our lives. For instance, if we invest $1,000,000 for 50 years at an average growth rate of 7%/year and a total annual investment cost of only .5%, we will have paid a total of over $1.9 million to our financial advisor, the funds in which they place our money, and those who execute purchases and sales of our various investment assets. For alternative classes such as hedge funds, private equity, and venture capital, this number balloons to over $7.2 million because such investments often charge a 2% management fee and 20% of all growth.
How much it should cost to invest is difficult for anyone to definitively state, but even those of us who make the most money will want to understand exactly what one gets for $1.9 million dollars. Can we imagine paying $1.9 million dollars for a house and not knowing every last feature and what comparable houses cost? Of course not. It should be the same with our investment costs. Price matters! Unless we take the time to understand how much we truly pay every year, how that price stacks up against the competition and what we get in return, we run the risk of getting abused if we have entrusted our earnings to someone whose ethics are not what they should be.
Below are a few costs that aren’t always readily disclosed by financial advisors:
- Fund Fees
- On top of what a financial advisor charges us to advise, they will place our money in funds that will annually charge us a percent of our assets for their investment “expertise.”
- On top of charging an annual fund fee, some funds will charge a sales load. As an example, if we invest $100, many funds will take $5 on day 1. This 5% loss requires the manager to book a 5.26% gain just to get us back to where we started.
- Every time we buy or sell a stock or bond, somebody gets paid to complete the transaction. If a stock fund has 100% turnover, that means that every stock that was in that fund on January 1 of a given year has been sold and replaced by another stock by the end of the year. These little charges add up. Some popular literature estimates that 100% turnover will cost us another 1% of our assets each year.
- These are a very expensive byproduct of high turnover. We pay taxes every year on stock dividend payments and taxable bond interest payments. All of the other growth an investment experiences goes untaxed. These are called unrealized gains. Unrealized gains are great because they essentially grow tax-deferred until we decide to sell the associated investments. At that point, we have to pay the government its share of the investment’s growth. If we are in the highest tax bracket and have owned the investment for more than one year, the U.S government gets 23.8% of the growth. On the other hand, if we sell an investment that we have owned for less than a year, the U.S. government gets 39.6% of the growth. Regardless, constantly buying and selling investments generally cripples our overall investment returns.