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Investing Costs That Will Devour Your Returns (And How to Avoid Them)

Posted: 06/28/2012 12:53 pm

What's a reasonable fee to pay for investing your own money? The answer: Much less than what you're probably paying for your 401(k) -- and the worst bit is you might not even realize it.

According to a report from New York-based think tank Demos, 401(k) fees can cost the average household as much as $155,000 over the course of a lifetime. Yet many employers have no idea when it comes to the fees they and their employees pay for their 401(k) plans, a recent report shows.

Until recently, mutual funds have been notoriously opaque about how much is being charged for trading or administering an account. Thankfully, as of next month, The U.S. Labor Department will begin requiring extensive disclosure of all 401(k) charges.

This is good news, but it doesn't help explain what's reasonable. How do you know when you're paying too much?

Here are some tips for avoiding return-eating fees:

1. Make Cost Matter

The value of an investment is, ultimately, in the returns. You should be wary of any fund or manager that charges high fees (1 percent or more), because high costs will only drain your savings. 1 percent might sound tiny -- but it can work out to be a third of all returns after tax and inflation.

Be wary of managers or products that claim that high fees are worth it because they get better returns. A study by Morningstar found that low-cost funds outperformed high-cost funds in every single time period and data point tested. It's simple: keeping costs low is the smart way to invest.

2. Know Your Fee Plan

Not all accounts are created equal. Some products charge broker fees for every trade while others charge a percentage of assets under management. Some products require you pay for a wire transfer in order to fund your account. These costs can add up. According to the Wall Street Journal, mutual funds charge hidden fees that can make a fund two or three times as costly as advertised.

3. Align Your Interests

In a previous life helping banks make more money, I saw product after product that was designed for corporate profit over customer value. When building my company Betterment, an online investment product, I made aligning interests a priority. When our customers make money, we make money.

It might come as a surprise to learn that not all financial advice is in your best interest. Brokers make money off of the products they sell you -- so the more you pay, the more they earn, or in some cases, the more you trade the more they earn (and excessive trading is definitely not in your best interest).

"Fee-only" is a preferable approach -- but beware of financial advisors who overcharge. This is not in your best interest either (see #1).

4. Be Suspicious of Big Promises

Few people can consistently outperform the market. Be wary of anyone who tries to convince you they have the secret sauce. Their returns would have to be significantly better than the market in order to offset the costs incurred by their active trading.

Instead, think about what's important to you in life and make a pact with yourself to achieve it. Dedicate a percentage of each paycheck to your goal, and invest it in the broad market portfolio. It might not be as intoxicating as tall tales of above-average returns, but the likelihood of you achieving your dreams is far greater this way -- and that's anything but boring.


Jon Stein is the founder and CEO of Betterment. Passionate about helping people make smart decisions with their money, he founded the online investment product in 2008. Jon is a Chartered Financial Analyst (CFA), a Series 7, 24, and 63 Registered Securities Representative, and a graduate of Harvard University (Economics) and Columbia Business School.

His interests lie at the intersection of behavior, psychology, and economics. What excites him most about his work is making everyday activities and products more efficient, accessible, and easy to use.

 

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