How to perform an account checkup to minimize investment fees (Simple Saver Series)

How was everyone’s Labor Day weekend? I spent mine relaxing beach side (and by relaxing I mean furiously finishing grad school applications in between beach jaunts). Though I’ll miss Summer, now that we’ve hit September I’m looking forward to boots, sweaters, and pumpkin flavored everything. Or at least I will once the temperature drops down from 90 degrees here in DC in a few weeks. In the meantime, I have one September change you can already get started on – this month’s Simple Saver Series challenge! This month’s challenge is a quick, but super effective one: just a few simple steps to minimize investment fees.

This month’s Simple Saver series is a departure from the norm, where we normally chat about giving up an item like Starbucks or shopping. But the investment fees challenge is awesome for two reasons: 1. You can set aside an hour and be done with it for the rest of the month, and 2. It has the potential to save you tens of thousands of dollars.

How, you ask? Well, investment fees can mean a big hit to your savings. Whenever you invest in a fund – a grouping of assets – you have to pay a fee for that bundling. Fees for passive funds, like index funds, are pretty low since an actual human doesn’t have to make investment decisions or manage the fund all that much (i.e. the passive name). On the other hand, fees for actively managed funds, like most mutual funds, are going to be on the higher side, since you’ll need to pay for the manpower behind managing the assets for you.

Fees tend to range anywhere from 0.05% for an index fund, up to 2% for an expensive, actively managed mutual fund. That might not sound like a lot to you now, but the problem is that those small fees can really add up over time.

Let’s say you invest $2,500 in a retirement account this year, and increase that contribution by 1% a year. If you retire in 30 years, you’ll have contributed almost $87,000 over that time period. And if you earned an annual rate of return of 8% on your contributions, your money would be worth $177,278 in 30 years, excluding any fees.

1% in fees on your initial $2,500 contribution is only $25. So what’s the big deal when you’re talking about so much money? Well, keep in mind that you’re paying 1% every year. And as your savings increase, so does the amount your pay in fees. In this example, if your fund cost 1% annually, you would pay $25,751 over 30 years (assuming your money grows at that 8% annual rate). That means you paid enough in fees to buy a car!

It gets even worse when you think about the fact that you could have invested the money you spent on fees. If you invested the money spent on fees in the market at 8% annual return, you’d have $61,425 after 30 years. In other words, not investing the fees more than doubles their cost to you. Ouch!

So what should you do? Minimize your fees, of course! As you can see above, just reducing your average fee spending by 0.05% can mean an extra $30,000 in your pocket at retirement. Not too shabby.

You can minimize fees across any funds investment, whether it’s in your 401k, IRA, or regular investment account. Since I realize that your retirement account can be a pain in the butt to deal with, I’m going to walk you through how you can change your investment elections in your 401k account to minimize fees. Your 401k is a great place to start since you can only invest in funds in it, which means it’s likely the place costing you the most in fees. To get a sense of how much you’re paying in fees you can either look at the details of each of your investments in your account, or use a free tool like Personal Capital’s fee analyzer to calculate your fees for you.

As a rule of thumb, I don’t invest in any funds that charge over 1% in fees. Though you might assume that a higher cost funds has a better rate of return, studies show that there’s no correlation between the cost of a fund and it’s return. I actually did a quick scan of my own 401k election options, and saw that most of the higher cost funds actually did worse in the past year than the lower cost funds did. On top of that, since you can’t ever control how well your investments perform, you might as well manage what you can control – how much you’re spending on fees for them.

Here’s how you do it:

[TDT Note: I have my accounts in Fidelity so all of my instructions and screenshots are based on their website. I’m assuming the process is similar for other institutions, but feel free to ask specific questions for your accounts in the comments or via email.]

First, go to your account positions, and click on an individual fund’s name to see details on the fund. You’re looking for the fund’s expense ratio. Make sure this ratio is below the max you’re willing to spend on fees (mine is 1%) and jot down a note if it’s higher than that amount.

Second, within the account positions page, click on any of the investments in your portfolio, and then click on “exchange.”

Third, select your method for exchange.

A. Change investment elections – this will only affect future investments, and any existing holdings in your high expense funds will remain in your account. I only recommend this one if you are working with a new account or will be charged high fees for selling funds.

B. Exchange one investment – use this one if only one of your funds violates your expense ratio threshold. Then you can swap that fund out for a lower cost fund.

C. Exchange multiple investments – if you have multiple funds that violate your expense threshold, or you follow an asset re-balancing strategy, choose this option to re-allocate your entire investment portfolio. This allocation will apply to both past and future account contributions.

From there, it should be pretty straightforward how to select new investment options. Look at each option, and weight the fund’s expense ratio, historical returns, and investment strategy to determine which ones would be the best fit for your portfolio.

If you’re already an investment fees master and looking for another way to minimize your investing costs, check out my recent post on two ways to trade for free.

Seriously, I know this is a complicated topic so don’t hesitate to reach out for help!