Saving for the future is hard enough when you’re so mired in student debt that just making rent is a struggle. To make matters worse, more often than not, the funds you're investing in for retirement come with hidden fees that eat away at your earnings every year.
That's right. Annual fees on mutual funds and electronically-traded funds (ETF) average 0.74 percent and 0.44 percent, respectively. That may sound like chump change, but over a typical lifetime you could easily wind up end up paying hundreds of thousands of dollars in investment fees alone. (Here’s a calculator you can use to run your own numbers.)
For the most part, there really is no reason for these charges. “If you are going to be in a passive index fund you shouldn’t pay a lot for it and every dollar you save in fees goes down to the bottom line,” said certified financial planner Jill Schlesinger.
There are ways to avoid—or at least lower—these fees. In August Fidelity introduced two index funds with no annual fees, and Vanguard eliminated trading fees on most ETFs, for a total of nearly 1,800 commission-free options. Schwab, meanwhile, has more than 250 commission-free ETFs, while TD Ameritrade has more than 300.
How to lower your investment fees
The first trick to lowering your investment fees is figuring out how much you're paying in the first place—no easy task since this figure is often buried—then switching to lower-fee funds.
Start by logging into your retirement account and scanning for the words “fees” or “expense ratio” for each fund you own. Vanguard lists these numbers right next to the name of each of your holdings, but Fidelity makes you do a bit more digging. If you can’t find the figure, pick up the phone and ask a customer service representative.
If you’re paying more than one percent in annual fees for any mutual fund or half a percent for an ETF, it’s time to find a lower-fee equivalent. Many sites will list similar investments, along with their fees. (For example, Fidelity lists funds similar to its Contrafund here.) Alternately, you can do an online search for similar funds by checking financial sites like Kiplinger for more objective recommendations.
For the biggest savings, consider switching from a mutual fund to a similar ETF. For example, the Dodge & Cox International Fund has an expense ratio of 0.63 percent whereas the Vanguard FTSE Developed Markets ETF, which has a similar investing style, charges just 0.07 percent. This mutual fund to ETF converter can help you find cheap ETFs that are similar to pricier mutual funds.
Just watch out for the tax man
If your high-fee funds are in a retirement account you won't pay any capital gains taxes when you make the switch. But if the funds are in a taxable account, you’ll have to pay taxes on any profits, even if you reinvest that money right away. For example, if you put $1,000 in a mutual fund three years ago and it has gone up 35 percent since then—like the Vanguard 500 has—you'll owe taxes on that $350 profit unless you take advantage of some tax-free conversions from mutual funds to ETFs that Vanguard offers. (You'll still have to pay a $50 fee for each conversion.)
A relatively small tax hit now may well be worth it in the long run though. “There might be value in going from an expensive fund to a low-cost ETF if the difference is so great that it justifies the tax implications of the capital gains, particularly if you’re going to buy and hold,” certified financial planner Douglas Boneparth said. That's because over time, your total earnings will far exceed the taxes you pay now. Just make sure you’ve got enough cash to cover the bill from Uncle Sam.
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