It’s easy to focus on your investment choices and your returns. But tax implications and investment fees can have an equally powerful effect on your finances.
Perhaps you want to travel the world, buy a vacation home, leave a stack of money to your grandchildren or make a major impact through charitable giving.
It would be a shame to sacrifice some of your ultimate goals, dreams and opportunities simply because you paid someone or some company more than you needed to in order to let them invest your money.
In this article, I’ll pass along money expert Clark Howard’s advice on reasonable and unreasonable investment fees for every major investment type.
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How Do I Know if I’m Paying Too Much in Investment Fees?
On a recent podcast, a listener wanted to know whether he was paying too many investment fees. He told Clark he pays 1.5% in annual fees for a large national firm to handle his investments from him.
Is that too much, I wanted to know? You can probably guess Clark’s answer.
“That is extremely, extremely high cost,” Clark says. “And you’re paying for someone who may or may not be required to do what’s in your best interests. They’re likely not a fiduciary. And even if they are, they’re the most expensive fiduciary out there, at 1.5%. Even if you want a lot of hand-holding, you can get that much, much cheaper than what you’re paying right now.”
That gets to the crux of the question I asked in this article’s title. You may know what a fiduciary is. You may even realize that paying someone 1.5% to manage your investments is steep even for the highest level of financial service.
But you may not know the optimal fee percentage for every major investment type.
It’s hard to make the right choice without good information. In this article, I’ll break down the difference between what’s valid and what’s too expensive for different types of investing.
Types of Investing
So you want to limit your investment fees to something reasonable. Recognizing the importance of that puts you ahead of the game. But the answer on the fee level you should consider depends on what type of investing you’re doing.
Here’s a quick overview of some of the major investment types.
- Self-investing: If you invest outside of a retirement account, you’re likely in what’s considered a “taxable” account. There are dozens of well-known options. Clark’s favorites are Fidelity, Schwab and Vanguard. There isn’t any hand-holding when you invest on your own. You’re calling the shots.
- Retirement accounts: The most common types of retirement accounts are 401(k) plans and IRAs (Individual Retirement Accounts). But there are lots of different types, including specialized funds for the self-employed, government workers and those in certain other public careers. These accounts often come with tax benefits.
- Robo-advisors: Want to invest but need some help making smart choices on how to allocate your money and/or manage your taxes? A robo-advisor is a strong option.
- Financial advisers: Do you need hardcore financial planning beyond investment choices? Often our finances get much more complex if we have large families, if we’re business owners or when we accrue some level of wealth. Most people don’t need a financial advisor. But if you do, it’s important to pick the right one.
Self-Investing: Investment Fees To Accept & Avoid
Investing was prohibitively expensive for individuals as recently as the 1970s.
Today, we take it for granted that it’s possible to press a few buttons on your phone and buy a fractional share of any stock you want in seconds — for free.
That wasn’t at all the case when Charles Schwab invented the discount brokerage in September 1975. More recently, Robinhood launched in April 2013 and rolled out free stock trading.
Now, most serious investment companies offer free stock (and ETF) trading.
However, Clark is a big fan of index funds. An index fund is a specific type of mutual fund that gets you broad market exposure.
Funds tend to hold stocks from many different companies. Sometimes hundreds of them. They often have to rebalance their holdings. They’re also constantly buying and selling positions as people enter and exit their financial positions with the fund.
Mutual funds also require management overhead. That differs depending on whether the fund is active or passive (index funds tend to be passive).
As a result, funds are almost never free. The Fidelity Zero funds are a major exception. Vanguard, which is the grandfather of index funds, charges investors 0.09%, on average. It’s considered the gold standard for company-wide fees.
According to Clark, if you invest in index funds outside of a retirement account, you should be looking to pay total annual fees of 0.15% or less.
Retirement Accounts: Investment Fees To Accept & Avoid
This is where things start to get a little complex.
Let’s take the two biggest retirement account categories and focus on those.
A workplace 401(k) plan is one of the greatest possible retirement tools, especially if your employer offers a company match.
There’s also an untold number of stories, videos and HR pamphlets evangelizing the benefits of 401(k) plans, including on Clark.com. However, there’s surprisingly little guidance on the investment fees within 401(k) plans.
Companies hire third-party custodians or administrators to handle their 401(k) offerings. Often the third party is a reasonably-priced company such as Fidelity. But some options are overly expensive. In general, large corporations are able to offer better fee schedules to their employees than small businesses.
According to Clark, your total annual fees — including the combined expense ratio of your investments and any management fees you have to pay — should be no more than 0.5% within a workplace 401(k) plan.
If that’s true for you, you don’t need to fuss with an IRA until you’ve reached the maximum contribution limits for your 401(k), Clark says. Otherwise, you should put in enough money to maximize your 401(k) company match.
An IRA may be slightly cheaper, especially if you open an account with one of Clark’s favorites. Assuming you follow Clark’s advice and stick to target date funds, you should be able to pay 0.2% or less in annual expense ratios.
Robo-Advisors: Investment Fees To Accept & Avoid
A robo-advisor is similar to self-investing in that it’s done outside of a tax-advantaged retirement account. However, instead of you making all the buy, hold and sell decisions, you’re passing on that responsibility to automated software at a trusted company.
Typically, there’s little to no customer support. Often you won’t be able to call and talk to someone on the phone. Although there are some hybrid models that combine the automated functionality of a robo-advisor to extremely minimalistic financial planning — often not nearly as much as you’d get with a full-fledged fiduciary financial advisor.
Most of the best robo-advisors charge a base management fee of 0.25% with weighted expense ratios of 0.1% — or a combined 0.35%.
The hybrid robo-advisors, such as Vanguard’s Personal Advisor Services, start at a fraction higher than 0.35% and go up to about 0.5%.
Financial Advisors: Investment Fees To Accept & Avoid
Perhaps the most complicated of all investment types is hiring a financial advisor.
Many people mistakenly think that financial advisors exist only to help you make a little bit more money on your investments. That’s not the case.
The benchmark for a fee-only fiduciary financial advisor tends to be 1% in annual fees. If all you need is help with your investments, you can save big-time on those fees by going with a robo-advisor.
If you do hire a financial advisor, it’s vital that you hire a fee-only fiduciary. Otherwise you likely will be subject to absurd commissions that can help line the pockets of your so-called advisor rather than your own.
It’s also possible to hire a financial advisor by the hour if you need short-term advice on something specific. Clark recommends the Garrett Planning Network for this. You’ll pay a steep per-hour fee. But if you have significant assets, it shouldn’t be anything like paying 1% on your total assets in perpetuity.
How Do You Know Which Type of Investing You Should Choose?
Without knowing your personal circumstances (age, goals, assets, risk tolerance), it’s next to impossible to tell you precisely how you should invest.
However, it’s possible to do so in broad strokes. If your company offers a 401(k) match, that’s free money. Take every penny of it if possible.
Retirement accounts such as 401(k) plans and IRAs have major tax advantages, whether you invest in a traditional or Roth version. So until you’ve maxed out those accounts, you probably shouldn’t consider seriously investing outside of them.
Someone investing outside of a retirement account who doesn’t have the time or knowledge to manage their investments should consider a robo-advisor. If you want to take more risks — which Clark doesn’t recommend when it comes to your retirement investing — buying on your own through a brokerage is a good option.
Finally, if your combination of financial situation is complex due to some of a large stockpile of assets (often at least seven figures), your own business or a complicated family situation, you can consider hiring a financial advisor.
After you pay your high-interest debt and secure an emergency fund, investing toward your retirement is your highest financial priority, Clark says.
However, the fees you pay can make a difference of hundreds of thousands of dollars during your investing lifetime.
Researching and comparison shopping isn’t fun on the best of days. But the consequences of picking wrong because you haven’t informed yourself are much, much higher with your investment choices than, say, buying a gallon of milk.
Take the time to understand the fees you should be paying for the type of investing you do.