How mutual fund fees can cost you big bucks

Robert Farrington from The College Investor recently went to bat for one of his readers. “I feel like my advisor isn't steering me in the right path,” his reader told him. “When I mention [index funds] to him, he changes the subject or diverts to other topics.”

Farrington ran the numbers and discovered that his reader's financial advisor stood to gain $7247.50 in commissions by recommending expensive mutual funds. But that's not all. “When you add in the expense ratio, this portfolio is costing the investor $11,004.71 in year one,” Farrington writes. “And potentially costing the investor $1,879.21 or more per year after!” (And that doesn't include any commissions and fees created by rebalancing the portfolio periodically.)

Mutual Fund Fees

As an experiment, Farrington looked at what it would take to move his reader's existing portfolio to low-cost index funds. The results were shocking: “By simply investing in a low cost portfolio, we were able to reduce total costs from $11,004.71 to just $176.60. That's a 99% reduction in costs.

This reminds me of a story from my own life.

Boxed In by Bad Investments

Before my father died in 1995, he set up a profit-sharing plan for the employees of the family box factory. Each year, the company contributed some amount (up to 15% of all employees' earnings per year) into an investment account. Because we didn't know any better, we used a big-name brokerage firm to manage this money.

My cousin Nick, who is a bit of a money nerd, kept records for the box company. After a few years, he noticed something strange. Although the stock market was booming because of the tech bubble, our investment accounts were not. In fact, they were barely growing at all. He did some digging and his research left him fuming. We had trusted that the big-name brokerage firm was doing their best for us, but that wasn't the case. They were doing their best for themselves.

When I asked Nick if he remembered this (after almost twenty years), he certainly did. “It pissed me off,” he said. The brokerage had us invested in what was called a Unit Investment Trust. Here's how Nick describes the situation:

The Unit Investment Trust consisted of a bundle of stocks selected to be purchased by [the brokerage firm] to meet some investment criteria. Units of this bundle could be purchased for $1.00 plus an 8% commission.

At a specific time they purchased the stock and held it for one year. At the end of the year they sold the stock and took their 4% management fee and distributed the rest of the funds to those that had purchased units. Then do it all over again. I don't recall the actual commission and fee rates but it seems that the total was about 12%.

That coupled with normal management fees of 3-5% for their funds (plus commissions) are what convinced me I didn't like [the company]. By comparison, Vanguard's Growth and Income Fund has a expense ratio of 0.34%. Vanguard's 500 Index Fund has an expense ratio of 0.14%.

Can you believe it? The big-name brokerage was screwing us over to the tune of nearly twelve percent per year. It's this kind of bullshit that makes me such a vocal advocate of do-it-yourself investing with index funds. I don't care what kind of returns your broker promises you. They're not going to be enough to compensate for fees of 12%! (And yes, I know, there are ethical advisors out there. But how can you tell the good from the bad?)

This is also an example of why one of the core tenets of Get Rich Slowly is nobody cares more about your money than you do. It's very easy to trust professionals — whether they're brokers or realtors or, well, bloggers — just because they have perceived position of authority. The advice that others give you is almost always in their best interest, which may or may not be the same as your best interest. Do your own research, get advice from a variety of sources, and in the end, make your own decisions based on your own goals and values.

Den of Thieves

At the end of his article at The College Investor, Farrington writes:

The sad part of this is that it takes a lot of time and effort to figure out what you're actually paying your financial advisor. I spent about an hour researching the fees, expense ratios, and commissions that the financial advisor was receiving for this article. And most people won't be spending their time doing that.

I really wish more advisors were up front, honest, and transparent about their fees. It's why I really like fee-only financial planners. You pay a flat fee up front and get a financial plan that you can execute.

For an even longer take on how Wall Street takes your money (legally), check out Todd Tresidder's rant at Financial Mentor. He too wants better disclosures:

I believe it should be illegal for any broker, financial advisor, fiduciary, brokerage firm, salesperson, or anyone else having contact with a client’s money to receive any compensation or distribute any payment related to that account that isn’t clearly disclosed upfront and direct in the form of a financial statement.

Written disclosures in contracts aren’t adequate because few people read or understand them, and not having any disclosure is completely unacceptable. You must show the client the money – that’s the key point.

If you really want to be grossed out by the pirates of Wall Street, read Den of Thieves, the 1992 bestseller from James B. Stewart. This book recounts the insider trading scandals of the 1980s, when names like Ivan Boesky and Michael Milken were prominent in the news.

Den of Thieves didn't just open my eyes to the actions of these well-known crooks; it exposed just how much money the big-name brokerages as a whole bleed from our economy. And they do it by taking advantage of everyday people like you and me.

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Peter Mueller
Peter Mueller
2 years ago

man, and canada is supposed to have the highest mutual fund fees in the world, even leaving the US behind in that regard. I wonder when this data will embarrass the industry into change. guess money talks

dh
dh
2 years ago

And as I mentioned in another post, it doesn’t help when super popular gurus from the PF world are mixed up in this bullshit themselves, like Dave Ramsey for example, who is in business (via his “Endorsed Local Provider” program) with brokers earning the kind of fees and commissions talked about in this blog post. Instead of telling listeners to simply invest for themselves in something like VTSMX, Ramsey steers people into the murky waters of Wall Street.

Don
Don
2 years ago
Reply to  dh

TOTALLY AGREE!!!! Shame on DR

dh
dh
2 years ago

In case anyone doesn’t realize how insanely simple this investing business is: 1) Find your cell phone and call Vanguard at 877-662-7447. 2) When the employee at Vanguard answers, you say, “I want to open a Roth IRA, and then I want to invest that Roth IRA into VTSMX. I’d like you to automatically debit my checking account each month for $458.33 (or whatever amount you can afford). 3) You hang up the phone and go back to watching cat videos on YouTube. Congratulations, you are now investing the way Warren Buffett recommends, the way JD recommends, the way every… Read more »

Jason@WinningPersonalFinance
2 years ago

These stories make me so angry. Many people need help with their money. It’s such a shame when you hear about “advisors” ripping their clients off.

DavidV
DavidV
2 years ago

I had a sales person from a major brokerage house call me at work last week. They asked for 10 minutes of my time to tell me about the great deal they had. ETF’s they explained “really” cost over 1% to only match the market, so pay them 1.5% to beat it. I asked if they could give me the 30 second spiel of why they are better than ETFs and why I should listen to someone who just cold called me and not someone like Buffett. He explained Buffett buys whole companies not ETFs, so why listen to someone… Read more »

WantNotToWantNot
WantNotToWantNot
2 years ago

YEP. We moved most of our funds (some have to be moved in increments) to Vanguard from TIAA-CREF. Yep, that big ole TIAA-CREF is still saying it was founded as a nonprofit (which it has not been for more than a decade) and is for the customer. No, it isn’t. Our accounts cost us in the neighborhood of $10k plus per year, each. And for what? The TIAA-CREF advisors always say they are paid by the company so they don’t try to sell you anything, but at the last meeting with ours, he told us he thought we should buy… Read more »

WantNotToWantNot
WantNotToWantNot
2 years ago

The problem is also political cover for the complicated “private equity markets” that buy and strip companies, taking all the money and bankrupting them, leaving workers without pensions and without jobs. This is from the NYTimes this week: …Commerce secretary, Wilbur Ross, is another prominent private equity operator. In 2002, Mr. Ross bought several steel factories that had been closed; he reopened them after persuading the steelworkers union to take major cuts. When he cashed out three years later, he made 14 times his original investment of $90 million. According to the economists Eileen Appelbaum and Rosemary Batt, “his three-year… Read more »

Kevin
Kevin
2 years ago

My family stopped all financial attachment with Wells Fargo after my grandfather died. He left us a segmented portfolio with them and both my mother and I drafted a clear signed document on what transactions and work we wanted from them. Two years later I find out not only had they violated their agreement to suspend short term trading in the account, they had tripled it. I brought this up to my advisor whose response was: “But you beat the average by $300 dollars.” After generating $3000 in short term taxable gains. They cost me more money than just parking… Read more »

Accidental FIRE
Accidental FIRE
2 years ago

Amen! When I started investing I went mostly with Index funds, but did buy a few actively managed funds. I didn’t pay adviser, but I hoped I could pick winners myself. Well, they’ve done about the same as their associated indexes over the years, and of course with the fees on top my gains have been reduced. I was going to sell them late last year but after the last election, figuring Republicans would cut cap gains taxes, I thought it’d be smart to wait. I could save lots of $ on my gains if they cut it back. Alas,… Read more »

Lady Dividend
Lady Dividend
2 years ago

What a timely article. Last night my fiancé and I were going over options for his retirement savings since he was just let go. The investment firm send him a list of 30 different funds and only listed their returns not the management expense ratios. Shifty!!!

I encouraged him to open a trading account and we went over why I recommend low cost ETFs like Vanguard. I’m going to send him this post to drive the point home.

Wise Money Tips
Wise Money Tips
2 years ago

Minimizing investment expenses is critical. Even a small difference in fees can make a significant impact on your portfolio’s value over time with compounded returns.

Dale
Dale
2 years ago

I used to split my investments 50/50 between index and active funds – more diversification! I had all these filters to try and pick only the best mutual funds based on Morningstar ratings, sharp ratios… Nobody reading this post will be surprised to read that the index funds beat the active funds. So about five years ago I got smart and haven’t looked back.

Now I get a kick when I check the Fee Analyzer on Personal Capital. They set a goal of 0.5% but it it pretty easy to get to 1/10th that with index funds.

MB
MB
2 years ago

This is what is frustrating about people not understanding investing and getting taken advantage of. The majority of people have no interest in understanding financials and are willing to hand their money over to financial advisors who are really looking out for themselves. For the majority of people heading to vanguard and setting up some automatic investing to low index funds is all they would need to do and it would save them thousands of dollars in fees over there lifetime. I assume the other thing to watch out for is 401K plans and ensure the fees are low in… Read more »

Alexander
Alexander
2 years ago

There is a good episode from John Oliver about this:
https://www.youtube.com/watch?v=gvZSpET11ZY

Ron Cameron
Ron Cameron
2 years ago

I’m always baffled and a bit disappointed by the across the board bashing of ALL active funds and financial advisors. Despite most of them being sub-par, there ARE good active funds that, after all expenses and through no trickery, have beaten their indexes for decades. Or they may have reduced volatility with results similar to their index instead. Several are ironically included in the above list. As for financial advisors – some are bad (like every other profession) but the majority I’ve worked with (professionally and personally) provide an honest service that clients want despite self-service options like Vanguard being… Read more »

Ajay Pruthi
Ajay Pruthi
2 years ago

Hi Roth This is an eye opener for me. Commission to agents upto the tune of 8%-9% ??? Here in India, we pay .5% commissions to the individual advisors and there is no portfolio management fee. But people crib about this point five percent fee also Its only when we go to big banks like HSBC or Citi, Portfolio management fee is charged Another thing, we have direct plan of mutual funds also wherein you can directly buy MFs from the company and you are not charged the fee. The only charges are fund management charges in the tune of… Read more »

Bernard
Bernard
2 years ago

I used to pick stocks for years, and I’ve done pretty well with it, mostly because my winners (Amazon, Netflix, etc.) have outperformed my losers (DDD, Chipotle, etc.) But due to my exposure to FIRE, I have started to buy Mutual Funds. First managed funds with a very long successful history (FSPTX, HJPSX, PRGFX, TRBCX), often reaching back decades, then Vanguard ETFs (through eTrade — commission free). I have a solid base of VOO now in our Traditional IRAs, while the Roth IRAs have still mostly stocks. But my wife’s dormant 401K is a sad story in itself. Located at… Read more »

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