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Why expenses matter

How competitive pricing on brokerage products can improve your returns.

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You can’t control whether stocks go up or down, whether interest rates rise or fall, or how fast the economy grows. But you can control a major factor that affects your bottom line: the amount you pay for investment products and services. Taking steps to reduce your fees may be among the easiest and most effective way to improve your investment performance.

But beware of simply chasing low costs. "Like anything you buy, investment products cost money," says Ram Subramaniam, president, Fidelity Brokerage Services. "The key for investors is to make sure they are getting a good value for the services they want and need. Lowering costs can help improve your performance and ensure that more of your return ends up in your pocket."

The fee structure of investment products varies, from annual percentage charges based on assets under management to transaction fees to fee-for-service or annual account fees. All of them vary by provider, and all can have an impact on your returns. Here we look at a few different types of investment and cash management fees to show how they can affect you—but this is just a sampling. You should consider the costs of all your investment products.

Mutual fund fees

Mutual funds come in lots of different flavors. Fidelity’s brokerage platform offers more than 10,000 funds, including passive index funds and exchange-traded funds (ETFs) that attempt to track a basket of stocks found in an index, and actively managed funds that attempt to outperform the market. Just as the different funds offer different types of services, fees can vary widely as well.

Virtually all funds and ETFs include an annual fee for investment management. They also charge for other services, such as recordkeeping, taxes, legal expenses, accounting, and auditing. Some funds also charge a marketing fee. All these expenses are included in the expense ratio—which is published in the fund’s prospectus.

Typically, index funds and ETFs charge lower fees, and attempt to re-create the performance of a benchmark index by holding a basket of stocks. Actively managed funds attempt to perform better than their benchmark through analysis of individual stocks and companies, and ongoing portfolio construction, and may charge higher fees. But even within the universes of actively managed and index funds, there are significant cost differentials. What’s more, within the same asset class, funds with low expense ratios tend to outperform peers with higher fees, according to numerous studies.

Expense ratios, however, don't capture all the costs investors should consider when selecting funds. There are a few costs that are not included in the expense ratio—including sales charges, or "loads," that are paid when you first buy a fund, which are often used to compensate an adviser for their advice. Some funds also charge deferred sales charges and redemption fees.

How much do fees matter? A fund’s expense ratio is subtracted directly from its annual return, and because costs compound the same way earnings do, even small differences in price can make a big impact over time.

Consider this hypothetical example shown in the chart below. You invest $10,000 in two funds, both of which earn a hypothetical annual return of 10%, but fund A charges 1.03% and fund B charges 1.71%. Fund A is a no-load fund, meaning there is no sales charge, but fund B has a sales charge. For investments up to $50,000, that charge is 5.75%, or $575 in this example.

Assuming the 10% hypothetical annual return, after 10 years, fund A would have a profit of $13,399, and fund B would have a profit of $10,604. In this example, a fund with no sales charge and an annual expense that was 0.68% lower ended up with 20% more investment gain over the 10-year period. Using the same rate-of-return assumptions, after 20 years, fund A would have delivered $44,751 in profit and fund B would have delivered $35,042.

Low cost doesn’t guarantee better performance, of course. Consider this hypothetical example calculated using FINRA’s Fund Analyzer. Fund C has annual operating expenses of 0.93%, and fund D is an index fund that charges 0.2%. For 10 years, fund C produces a 10.8% annual return, while fund D produces a 7.6% annual return. After 10 years, a $10,000 investment in fund C would have charged $1,536.81 in fees but produced $15,410 in net profit, leaving the hypothetical investors with a balance of $25,411. Fund D would have charged much less, just $292; however the fund would have produced a net profit of $10,391, leaving an investor with a balance of $20,391. The outperformance of fund C more than offset the additional costs in this hypothetical example.

Actively managed funds may charge higher expense ratios than index funds in the same categories, but some that consistently outperform the benchmarks may be worth the premium. The upshot: Consider value rather than just price.


The Fidelity value story

  • Trade 65 iShares ETFs commission free
  • $7.95 online trades and guaranteed one-second trade execution
  • Transparent $1-per-bond markup2
  • More than 1,700 no-transaction-fee and no-load funds on Fidelity.com
  • Free checking, no ATM fees, free mobile deposits, and free bill pay with the Fidelity® Cash Management Account
  • Margin rates that are among the lowest offered by discount brokers

Investors buying and selling individual securities are exposed to commissions and other fees that accompany those transactions, such as the flat per-transaction fee or percentage-of-assets commission they pay when buying stocks or ETFs.

These fees tend to be small in dollar terms, so you may simply accept them as a cost of doing business. But in the following hypothetical examples, they can have a more significant impact on your returns:

  • Small trades. Say you invest $1,000 in a stock but pay a $20 fee on the trade. You own $980 worth of stock. The stock appreciates 25%, so you sell your shares for $1,225. Then you pay a second $20 fee to execute the sale. The result: $40 in commissions reduces your 25% gain to a 20.5% gain.
  • High-volume trading. Say you invest $500 a month in ETFs, and you pay a $10 commission on each transaction. After a year, you’ll have invested $6,000 and lost $120 to fees, reducing your return by 2%.

Bond markups

Focusing on costs is especially important when investing in securities that may offer low return potential, such as bonds in the current interest rate environment. Most bonds have a face value of $1,000—which is known as par. A bond’s par is typically its price when it is issued, and that is the same amount that will be repaid when the bond matures. When the bond’s price changes, the bond price is given as a percentage of par.

You pay your broker a commission when you buy a bond—and that is pretty straightforward. But bonds aren’t traded on open exchanges the way stocks are, and there may be some less transparent charges. When you buy a bond on the secondary market, you pay the asking price as well as the markup—a transaction cost that is the difference between the price a broker-dealer pays for a bond and the price it is sold to you. With new issue bonds, the broker’s compensation is included in the face value, so you do not pay a separate transaction cost. But if you are buying a bond on the secondary market, it is important to consider the impact of bond markups on performance.

Markups can be small amounts, such as 0.1%, or more significant—some brokers charge more than 2% of a bond’s face value. Making matters tougher for investors is the fact that certain brokers bundle this fee with the bond price—making it hard to evaluate how much you are paying your broker. If those fees are large, they can take a big chunk out of your returns. Say you set up a bond ladder, investing $300,000 across three bonds. Comparing a 1%-per-bond markup with the 0.1%-per-bond ($1-per-bond) markup equates to a difference of $2,700 saved.

"Understanding bond markups is very important, particularly in today’s bond market," says Richard Carter, Fidelity vice president of fixed income products and services. "If you are buying a bond that yields 2% and you’re charged a 1% markup, you could erase a significant portion of your income and total return. That's why Fidelity aggregates one of the largest bond inventories available, from multiple providers, to encourage competition for the lowest price on a particular bond. We explicitly show customers the $1, or 0.1%, markup we are charging for the trade, which allows investors to retain more of the return for themselves."2

Margin rates

When investing on margin, you borrow money, using your portfolio as collateral, and invest it. The borrowed assets amplify your performance either positively or negatively. But costs can play a significant role in these transactions.

You pay interest on the loan, of course—and the higher the interest, the less of the return you get to keep (or the greater your loss will be). Say you buy $40,000 in stock, funded with $20,000 in cash and $20,000 in margin, and hold it for 90 days. A difference of 3% on your margin rate—for example, a 7% rate rather than a 4% rate—would cost you almost $150 more over that three-month time frame.

The longer the loan is outstanding, the more a higher rate costs in dollar terms. In the example above, you pay a daily interest cost of $2.22 for the 4% loan, versus $3.89 for the 7% loan. Holding the stock twice as long, for 180 days rather than 90 days, would double the additional interest cost from $150 to $300.

Cash management

Most banking fees may seem pretty minimal, but those costs can pile up. For example, the average ATM fee is close to $3; if you go to the cash machine every week, that could be more than $150 a year. A checking account may charge $10 a month, which quickly adds up to more than $100 a year, and when you add in minimum account balance fees, bank wires, and other service charges, cash management fees can quickly reach hundreds of dollars per year.

That’s why it’s important to look at the fees you pay and make sure they are competitive.

It is also important to consider what cards you are using for purchases. Annual fees can rack up expenses, while rewards credit cards can offer important benefits—including everything from airline travel to cash back for savings.

Cash management products are increasingly competitive, with many brokerages and banks offering free ATM withdrawals, no account fees, and other discounts," observes Subramaniam. "It makes sense for consumers to shop around for good prices on these services."

Managing the risk of paying too much

Diversification is sometimes described as investing’s only "free lunch," a way to reduce volatility without necessarily sacrificing returns. That’s not quite accurate: You can do the same by minimizing costs. Being mindful of fees and other expenses in your investment process can make a considerable difference in your overall return and your ability to meet financial goals.

"Investors have to weigh performance, service, and strategy along with cost when choosing products and services," says Subramaniam. "But it makes sense to consider value—because anything you save on fees can be put to work on achieving your real goals."

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Before investing, consider the funds’ investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully.
1. Source: Morningstar. "How Expense Ratios and Star Ratings Predict Success," August 10, 2010.
2. Other concessions or commissions may apply if traded with a Fidelity representative.
The offering dealer, which may be our affiliate Fidelity Capital Markets, may separately mark up or mark down the price of the security.
Investing involves risk, including risk of loss.
In general, the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible.
Diversification/asset allocation does not ensure a profit or guarantee against a loss.
Exchange-traded products (ETPs) are subject to market volatility and the risks of their underlying securities, which may include the risks associated with investing in smaller companies, foreign securities, commodities, and fixed income investments. Foreign securities are subject to interest rate, currency exchange rate, economic, and political risk, all of which are magnified in emerging markets. ETPs that target a small universe of securities, such as a specific region or market sector, are generally subject to greater market volatility as well as the specific risks associated with that sector, region, or other focus. ETPs that use derivatives, leverage, or complex investing strategies are subject to additional risks. The return of an index ETP is usually different from that of the index it tracks because of fees, expenses, and tracking error. An ETP may trade at a premium or discount to its net asset value (NAV) (or indicative value, in the case of exchange-traded notes [ETNs]). Each ETP has a unique risk profile that is detailed in its prospectus, offering circular, or similar material, which should be considered carefully when making investment decisions.
The expense ratio is the total annual fund operating expense ratio from the fund's most recent prospectus.
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