Keeping your money invested and working for you is a critical part of helping to grow your wealth over the long term. But even if you can resist taking your money out of the market too soon, there are still factors, such as inappropriately allocated assets or tax exposure, that can undermine your portfolio performance.
One of the least obvious impediments to long-term growth, however, are the fees that investors pay on their mutual fund or exchange-traded fund (ETF) investments. "Fees can really be a drag on performance," according to Matt Bullard, a regional vice president for managed solutions at Fidelity. "A lot of time, investors may not even realize there are fees associated with the individual investment choices they've made."
While small—often only a fraction of a percent annually—these fees can add up. Just as your returns may compound over time, so may your expenses, potentially leaving you significantly short of where you expected to be financially in the future. "It's really important for investors to understand what they are paying," says Bullard, "and the value they may or may not be getting for it."
While you cannot control whether the markets rise or fall, you can try to help reduce the impact that fees have on your portfolio—it just requires a close assessment of your investments and a clear sense of how they relate to your goals and personal circumstances.
What is an expense ratio?
Mutual funds and ETFs are baskets of securities, the composition of which are managed by investment companies. This management involves costs, which investment companies recoup by charging investors an annual fee representing a percentage of their investment in the fund. This is called the "expense ratio."
"The expense ratio of a fund is paying for security selection," says Bullard. "It covers the cost of having someone either replicate an index, or actively make decisions about what the fund should own and when to buy or sell it. It's paying for trading costs, accounting, reporting, as well as any kind of investment research and investor communications required for managing the fund."
In 2022, the average expense ratio for equity mutual funds was 0.44%; for bond mutual funds, it was 0.37%.1 For ETFs, the average expense ratio in 2022 was 0.16%.2 Depending on their composition and investment objectives, some funds will have relatively high expense ratios and some funds may have no expense ratio at all.
The expense ratio for a fund can be found in its prospectus, listed under "annual fund operating expenses." There, you'll find details on what exactly the expense ratio includes. Gross expense ratio, as reported in a fund’s prospectus, is the percentage of fund assets expected to be paid over a year for operating expenses, management fees, and interest and dividend expenses. Net expense ratio takes the gross and removes any contractual fee waivers and reimbursements. This is the cost borne by investors.
What you won’t see, however, is any kind of transaction record or line item denoting the payment of a fee in your account statement—the impact of the expense ratio is already included in how the net asset value of a fund is calculated.
It's understandable why an investor might overlook or fail to consider expense ratios when selecting investments. "A typical investor looking to invest in a mutual fund or ETF is likely to be much more focused on the historical performance of that fund and less so on the fee," says Bullard. "The fee may not seem to matter so much if the historical performance is attractive. But the fee is a guaranteed cost; what's not guaranteed is that performance."
The risk of not grasping the impact of the expense ratio can be significant. For example, if you invested $10,000 in a fund that produced a 10% annual return before expenses and had annual operating expenses of 1.5%, then after 20 years you would have roughly $49,725. However, if the fund had expenses of only 0.5%, then you would end up with $60,858—an 18% difference.3
Cheaper isn’t necessarily better
While there may be benefits to reducing the overall amount you pay in fees, it's important to understand that relatively high or higher-than-average fees are not necessarily a bad thing—provided you actually derive value from the investment. Some funds may be worth paying an above-average cost for, assuming they are aligned to your goals.
"Fees are really only an issue in the absence of value," says Bullard. "If you believe in active management—that there are people out there who are skilled and smart and have access to research that may help enable them to beat the indexes—you may be willing to pay a little more for that."
Some funds may have higher fees because they deal with types of investments that are more complex or less accessible than others, such as commodities or international securities. "International and emerging market funds tend to have higher costs, as it can be more difficult to do the research on the companies that may be included in the fund," says Bullard. "Additionally, there's a little more complexity in buying overseas investments, as they're often denominated in foreign currencies."
“You get what you pay for” is an adage for a reason. Low- or no-fee funds are no frills options—you’ll need to pay closer attention to their performance and their place in your portfolio to help ensure they’re still delivering the value you’re seeking. "If you aren’t comfortable doing that,” says Bullard, “it may be worth the cost to pay a professional to do it for you. Because the cost of not doing it could, in the long run, be greater.”
Assessing your overall fee exposure
The first step in reining in the effect of fees on your portfolio, according to Bullard, is awareness.
When working with investors, Bullard helps them to assess their overall exposure to fees by introducing them to a number called the Weighted Average Expense Ratio (WAER). WAER is calculated by adding up, then averaging, the expense ratios for all of the funds in an investor's portfolio. This provides the investor with a clearer sense of just how much of their potential returns may be lost to fees overall and gives them an opportunity to reflect on whether these costs are in line with their expectations and goals.
"It's very common for us to run this analysis for people and find that this number is higher than the investor thought," says Bullard. "They may have invested in these funds 10 or 15 years ago and forgotten how high the fees were, or maybe those were low fees back when they first invested but aren't anymore given how many more low- or no-fee options are available today."
With the knowledge gained from this assessment, an investor is better equipped to evaluate each of the funds that comprise the WAER and determine whether the fees they are paying for that investment are worth it in the context of their long-term strategy.
Consider your options
Investors who feel they are not getting the value they expect for the fees they are paying have a number of options available. They may want to consider swapping an existing, higher-fee investment for a similar, yet less expensive fund. Fidelity's mutual fund evaluator and ETF screener are equipped to help investors search through thousands of funds and allows them to filter and sort by many different criteria, including expense ratio.
For investors who are less inclined to go it on their own and are interested in deferring the responsibility of managing their portfolio to professionals, a managed account solution may be worth investigating. While such an option would carry an advisory fee of its own, the personalized investment management that such a solution offers may provide enough value to make it worth the cost, especially if you don’t have the time or the inclination to do it yourself.