Investment Expenses
The number one question every investor should ask when looking at a potential investment is:
How much does this investment cost?The reason an investor is investing in the first place is to make money. If an investment is exceptionally expensive then the only people making money would be those running the investment fund. Unfortunately, many people do not ask this question as they do not understand the answer. Even worse they understand the answer but think that an expense ratio of 1.00% is no big deal.
Every investment product should provide a prospectus which will include, among other information, the expenses of the investment. Here is a list of the typical investment expenses found in many prospectuses:
- Expense Ratio
- 12b-1 Fees
- Front End Load
- Back End Load
Great, we now have a short list of typical investment expenses! Let's dive under the hood and find out exactly what they are and how they affect our investments.
- Expense Ratio- An annual expense taken directly out of the investment which is generally represented as a percentage of your total investment. If your mutual fund was worth $10,000 and had an expense ratio of 1.00% then you would be charged $100 that year.
- 12b-1 Fee - An annual expense taken directly out of the investment. This fee is used to further advertise the fund.
- Front-End Load - A fee that is charged when you first invest in a fund. If a fund has a front-end load of 5.00% and you invest $10,000 then you will be charged $500. As a result your total investment would be worth only $9500 and already be behind a similar fund without a font-end load.
- Back-End Load - A fee that is charged when you withdraw money from a fund. This is similar to a front-end load except it will charge a percentage of the money withdrawn. If the specific fund had a back-end load of 5.00% then you automatically would pay 5.00% of the amount withdrawn.
The ultimate takeaway of this article is simple: Watch your investment expenses as they will take a large portion of your returns. Simply do not invest in any fund which charges 12b-1 fees, front-end loads, or back-end loads. Watch out for overly large expense ratios as well. As a general rule you should never invest in any domestic fund that charges more than 0.5% or any international fund that charges more than 1.0%.