Insights from Marie Chandoha
President and CEO
There’s an intersection close to where I live with two gas stations facing one another across the street. One regularly charges about five cents per gallon of gas less than the other—sometimes as much as a dime. As you’d expect, there’s always a buzz of activity at the less expensive station, and far fewer customers at the more expensive one.
Nobody likes to be nickeled and dimed at the pump—or most other places for that matter—but for some reason, we don’t seem to scrutinize pricing in the investment arena the same way we do other expenses. For example, some investors buy stocks and bonds without realizing the full cost of those securities. Likewise, many investors unknowingly buy high-cost mutual funds or exchange-traded funds (ETFs). And some investors overlook fees entirely. Why?
The obvious answer is that investment costs are not always clear. At the pump, we can’t miss the price per gallon. Those numbers stare down at us from a gigantic placard. They are listed on each individual pump. We watch as the numbers scroll by and add up. Investment fees, by contrast, are listed as line items in the fee table of a prospectus and on various monthly or quarterly performance summaries. They can be hard to find. They can be hard to understand. And they might not tell you the whole story.
Investment fees come in different forms and sizes and can be significantly corrosive to your returns—especially over long periods of time. There are commission fees for buying and selling stocks. For bonds, transaction fees can either be a per-bond fee or a percentage of your overall trade, and can vary widely.
Some funds charge a “sales load,” the money paid to a broker on the purchase (called a front load) or sale (the back load) of the fund. In some cases these can amount to more than 5% of the purchase or sale price of a fund, which erodes returns.
But not all funds charge loads (there are many “no-load” funds), so let’s spend a moment on an expense that all fund holders face: total expense ratio. The total expense ratio, or operating expense ratio (OER), is the cost of owning a fund and covers the fund’s operating expenses—portfolio management, administrative and other operating costs.
Fortunately, average total expense ratios have been falling. According to the Investment Company Institute1, in 2014 (the last year of available data), the average total expense ratio for mutual funds fell to 70 basis points (0.70%) from 99 basis points (0.99%) in 2000. Many investors prefer ETFs because they are a relatively inexpensive way to gain exposure to a diverse array of stocks or bonds (or commodities and other asset classes). According to ETF.com data2, the average net operating expense ratio for traditional passive, open-ended equity and fixed income ETFs is 44 basis points (0.44%), with some stock ETFs as low as 3 basis points (0.03%).
While the gaps between these numbers are miniscule, you’ll find that what appear to be small, insignificant differences in total expense ratios can erode your long-term earnings potential over time in a meaningful way.
For example, if you invest $100,000 in an ETF with an annual OER of 0.10%, after 20 years, you would have $314,359, assuming an annual return of 6% and no other fees. Invest the same amount in an ETF with an annual OER of 0.50%, after 20 years you’ll have just $290,120. In other words, the higher fees would have shaved more than $24,000 off your investment. That’s a pretty sizable haircut.
"...because investment fees aren’t beckoning from 100-foot poles like gas prices, we as investors have our work cut out for us. It begins by asking questions—a lot of them."
But because investment fees aren’t beckoning from 100-foot poles like gas prices, we as investors have our work cut out for us. It begins by asking questions—a lot of them.
Advisers need to play their part too, helping their clients lift the veil. For starters, every investor should understand the OERs on their funds. In addition, every investment decision should include a discussion about mark-ups, commissions, settlement costs and loads. Here are a few questions to ask:
—What fees are being paid to get into, or out of, this investment, and how do they impact returns? Who gets paid with those fees?
—What amount is paid annually in total expenses in order to be invested in the fund?
—Is there a contractual limit on the total expenses that can be charged?
Whether you’re an investor or an adviser, these conversations are certain to create stronger relationships. Tell me there’s a place where I can get my gas cheaper, and I’m going to thank you for it. Tell me there’s a way to potentially save tens if not hundreds of thousands of dollars over the lifetime of my investing career, and I’ll be grateful forever.
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Marie Chandoha is President and Chief Executive Officer of Charles Schwab Investment Management Inc. (CSIM), a subsidiary of The Charles Schwab Corporation. Chandoha is an Executive Vice President of Schwab and serves on the corporation’s Executive Council. With more than $265 billion under management, CSIM is one of the nation’s largest asset management companies, the third largest provider of index funds and a top 10 provider of ETFs and money market funds.* Since assuming leadership of CSIM in 2010, Chandoha has achieved record growth by developing a cultural commitment to providing investors with quality funds at a great value, managing them with integrity and examining risk from multiple angles. A passionate advocate for the interests of investors and the advancement of women in financial professions, Chandoha is considered one of the most accomplished and respected female executives in the industry. She was recently named one of the top women in asset management by Money Management Executive and one of the most powerful women in finance by American Banker.
*As of September 30, 2015.
1. Source: 2015 Investment Company Fact Book
2. Source: www.ETF.com, as of 12/31/15.
Past performance is no guarantee of future results.
The opinions expressed are not intended to serve as investment advice, a recommendation, offer, or solicitation to buy or sell any securities, or recommendation regarding specific investment strategies. Information and data provided have been obtained from sources deemed reliable, but are not guaranteed. Charles Schwab Investment Management makes no representation about the accuracy of the information contained herein, or its appropriateness for any given situation.
Some of the statements in this document may be forward looking and contain certain risks and uncertainties.
The views expressed are those of Marie Chandoha and are subject to change without notice based on economic, market, and other conditions.
The example is hypothetical and provided for illustrative purposes only. It is not intended to represent a specific investment product. Dividends and interest are assumed to have been reinvested, and the example does not reflect the effects of taxes or fees. If taxes and fees had been considered, performance would have been lower.
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