March 28, 2019
There’s a wonderful fight going on that will make winners of investors who are paying attention.
The major discount brokerages are so hungry for your investment dollars that they are reducing the fees you pay to buy (and sell) mutual funds and exchange traded funds.
It wasn’t so long ago that investors thought they were getting a good deal if the annual charge to own a mutual fund or exchange traded fund was less than 1%. If you were paying 0.50% you felt pretty good.
Well, 0.50% is now way too much to pay. And in my opinion, 1% is nuts.
That’s because in today’s world you can pay zero. Yep, the Fidelity ZERO Total Market index fund does not charge any expense ratio. Schwab charges as little as 0.02%. Neither Fidelity or Schwab has a set investment minimum. Vanguard typically requires a $3,000 initial investment, and its broad stock market index funds and ETFs charge as little as 0.04%. TD Ameritrade now offers ETFs from State Street (called SPDR ETFs) with expense ratios between 0.03% and 0.05%, and no commission. TD also offers low-cost mutual funds.
If you’re just shrugging right now, you are so missing how fantastic this is. I know it doesn’t seem like a big deal when you’re talking such small percentages. But it’s actually a huge deal.
A quick refresher: the expense ratio is a fee that doesn’t show up on your statements; it’s deducted from a fund’s gross return before your account is credited with a gain or loss. For example, if a fund earns 6% and its expense ratio is 1%, your net (after fee) gain will be 5%.
And the difference between paying 0.50% or more, compared to 0.05% or less is a very big deal.
Let’s say you have $25,000 in IRAs in a few mutual funds with an average expense ratio of 0.65%. If we then assume a 6% gross (before the expense ratio is subtracted) annualized return over the next 20 years, do you want to guess how much you will have in your IRA versus if you move the money to ETFs or mutual funds charging 0.03%?
Okay, I’ll tell you. If you don’t invest another penny in your IRAs (and that’s not my advice!), it will be worth around $71,000 in 20 years. If you move it to super cheap ETFs or index mutual funds it will be worth nearly $80,000.
You’re not going to just shrug that $9,000 more is no big deal. Right?
And here’s the great thing: if you already have your money at one of the discount brokerages, all I want you to do is check what you are currently paying compared to the lowest-cost index funds or ETFs offered at that firm. If you aren’t already paying 0.05% or less, I want you to consider moving out of your funds and into the low-cost options. You can do this with a few mouse clicks, and because the money is in an IRA you will not have any tax bill.
Now if you are at a full-service broker, I still want you to call up your advisor and ask what the expense ratio is on your investments. It is going to be a lot more than 0.05%. It’s up to you to decide if the advice you are getting is worth paying a higher expense ratio for. I respect that your advisor should be paid. But putting you in funds with high expense ratios (some of which trickles back to the advisor) is not necessarily best for you, especially if your accounts are large.
In my opinion, an advisor who charges a low flat fee and then invests your money in low cost funds and ETFs can be the smarter way to go.