Learn about the most common types of investments, stock trading, and brokerage fees. Learn where to look for them and how to save money. When you first begin studying where and how to invest and researching brokerage accounts, one thing is easy to overlook: investment and brokerage fees.
Definition of brokerage fees
Brokerage fees are what a broker charges for different services such as premium research and investing data subscriptions or additional trading platforms. Some even start charging maintenance and inactivity fees, but with the right broker, you can avoid paying these brokerage fees. Finding the right broker can make a significant difference in the long run; fees can significantly reduce your investment returns. It's vital to comprehend what you're paying, whether it's built into the funds you've chosen as an investment return, charged as an amount payable on your investment account, added on as a stock trading commission when you're buying and selling, or levied by an advisor assisting you in sorting it all out.Typical brokerage and investment fees
In addition to the brokerage fees mentioned above, you may encounter the following charges: A trade commission, a stock trading fee, is a brokerage fee charged when you buy or sell stocks. Other investments, such as options or exchange-traded funds, may also require commissions or fees when purchased and sold.- Mutual fund transaction fee is another brokerage fee charged when you buy or sell mutual funds.
- Expense ratio: A percentage of your investment in a mutual fund, index fund, or exchange-traded fund that is charged annually.
- Sales load: A sales charge or commission paid to the broker or salesperson who sold the mutual fund.
- Management or advisory fee: A percentage of assets under management paid to a financial advisor or robot-advisor by an investor.
The impact of investment and brokerage fees on returns
A small brokerage fee can quickly add up; a few investment fees combined can substantially reduce your portfolio's return. If your portfolio increased by 6% for the year but paid 1.5 % in fees and expenses, your return is only 4.5 %. That difference adds up over time. Consider the following scenario: an investor deposits $500 per month into a brokerage account each year for 30 years, depositing a total of $180,000 and earning an average annual return of 7%.Stock trading commission
Some brokerages charge commissions on stock and ETF trades, but these fees decrease. Look for the following to avoid them:- TD Ameritrade, Charles Schwab, E-Trade, Interactive Brokers, and Robinhood are among the brokers that offer commission-free trading.
- Limited time offers. Many brokers provide a limited number of commission-free trades to new customers in the first few months after opening an account. This should not be the primary reason for selecting a broker, but it could be a deciding factor.
- ETFs with no commissions. Even among brokers who charge trading fees, many have a list of ETFs that trade commission-free.
- Otherwise, depending on the online broker, trading fees range between $3 and $7. High-volume traders may be eligible for discounts from some brokers.
- When choosing a broker, you should consider the commissions on your preferred investments.
Transaction fee for mutual funds
Mutual fund trades, except ETFs, are not subject to brokerage commissions. They do, however, occasionally carry transaction fees, which are levied by the brokerage when the funds are bought or sold. Most brokers charge for both; some only charge for the purchase. These fees vary by broker and range from $10 to $75. (See our recommendations for low-cost investors' best mutual fund providers.) Fortunately, one can avoid transaction fees by choosing a broker who provides a list of no-transaction-fee mutual funds. TD Ameritrade provides over 4,100 mutual funds with no transaction fees.How much does it cost? Investors should be aware of mutual fund fees.
Many of the funds on this list will be from the broker, but other mutual fund companies frequently pay brokers to offer their funds to customers at no cost. This cost could be passed on to you in the form of a higher expense ratio (more on this next). Details can be found on the broker's website, usually on the same page where commissions are listed.Cost-to-income ratios
Mutual funds, index funds, and ETFs all charge expense ratios. They are shown as a percentage of your investment and are charged annually: A fund with a 0.10 percent expense ratio, for example, means that you pay $1 per year for every $1,000 invested. The expense ratio is intended to cover operating costs such as management and administrative expenses. Actively managed funds, which employ a professional to buy and sell their investments, typically have higher expenses than index funds and ETFs, which are passively managed and track a stock market index, such as the S& P 500. A manager's goal is to try to outperform the market; in reality, they rarely succeed. An actively managed mutual fund's expense ratio could be 1% or higher; an index fund's expense ratio could be less than 0.25 percent. That's a significant difference, so when choosing funds, pay close attention to expense ratios and choose low-cost index funds and ETFs whenever possible. The expense ratio also includes the 12B-1 fee and, if applicable, an annual marketing and distribution fee. 12B-1 fees are included in the total expense ratio, not added on top of it, but it's still important to understand what you're paying. Remember how mutual fund companies can pay a broker to offer their funds without charging a transaction fee? If the expense is passed on to the investor, it will be included in the 12B-1 fee. Details can be found on your broker's website, in the expenses or fee table in the prospectus, or on an independent research website such as Morningstar.com. A prospectus fee table from the Fidelity Freedom 2055 target-date fund is shown below:Sales volume
Mutual fund loads, unlike expense ratios, are entirely avoidable. They are essentially a sales commission paid by the investor to the broker or salesperson who sold the fund. Sales loads are expressed as a percentage and typically range between 3% and 8.5 %. (FINRA rules prevent mutual fund loads from exceeding 8.5 percent ).Loads are charged in a variety of ways:
Front-end loads are initial sales charges, also known as upfront fees. The fee is deducted from your fund investment, so if you invest $5,000 and the fund has a front-end load of 3%, your actual investment is $4,850.Back-end loads:
This is where things can get complicated. Funds with a back-end load do not charge an upfront fee; instead, they charge a fee when the fund's shares are sold. Generally, the fee is higher if you sell within the first year, and it decreases with each year you keep the fund until it disappears entirely after five to six years (this is why back-end loads are sometimes referred to as "contingent deferred sales charges"). Other back-end load funds charges, such as 12B-1 fees, may be higher. It's difficult for investors to predict how much they'll pay.Level loads:
These funds have no upfront sales charges, but a 1% fee is typically assessed if shares are sold within the first year. In this case, 12B-1 fees may be higher than those of funds with front-end loads, implying that the fund may be more expensive to own overall, even without a sales charge. Again, the best policy in this situation is to avoid these load charges. Choose no-load funds to accomplish this. There are numerous options, and the best part is that they tend to outperform load funds over time, implying that there is no added value in selecting a more expensive fund. Details can be found on the fund's page on your broker's website (usually near the expense ratio), in the expenses or fees table in the prospectus, or on an independent research website such as Morningstar.com.Management or consulting fees
You're probably paying someone to manage your money, a human or a robot advisor. Many financial advisors work on a fee-only basis, charging a percentage of assets under management, a flat or hourly fee, or a retainer. Others charge a percentage of assets under management and earn a commission on investments sold. In most cases, financial management by an advisor will cost you around 1%. Robo-advisors are firms that manage your investments using a computer algorithm, and they frequently charge significantly less because they remove the human element from the equation. A typical fee is 0.25 percent of assets; however, some advisors, such as Personal Capital and Facet Wealth, charge more because they combine computer monitoring with dedicated financial advisors. Should note that management fees are in addition to the costs of the investments themselves. Find details: Before signing up for a financial advisor's services, you should carefully review the fees. Management fees are clearly stated on the websites of Robo-advisers. You should be able to see how much you're paying in management fees on your account statements regularly.401(k) fees
You've probably heard that 401(k)s are expensive. This is due to two factors: they have a limited selection of investments, making it more difficult to shop around for low expense ratios. And the administrative costs of running the plan are typically high. Everything from record-keeping and accounting to legal and trustee fees is passed on to plan investors by many employers. Individual investors may be charged a percentage of their account value or a flat fee. Some generous employers pay the fees on behalf of plan participants, so you only have to worry about the investment costs. However, if your plan is expensive and your investment options are limited, you can reduce fees by contributing only enough to earn your employer's matching dollars. If you reach the annual contribution limit, you can return to the 401(k) to continue contributing. Then, in an IRA, continue to save for retirement.Are you looking for an IRA?
Where to get it:
The summary plan description in your 401(k) should outline the plan's investments, fees, and expenses. Don't hesitate to contact your human resources department or the plan administrator if you have any questions.