Beware of Fees
I like to think of income investing as a business, even for individual investors. The dividends you earn represent revenue, while the investment fees you pay are your expenses. By subtracting expenses from revenue, you get your net income.
In other words, if you are paying very high fees, it could significantly impact your bottom line. For income investors who don’t trade frequently, transaction costs paid to brokers likely won’t be substantial. Nowadays, there are plenty of discount brokers who allow you to buy and sell shares at less than $10.00 per transaction.
What could be substantial, though, are the fees paid to someone to actively manage a portfolio. For instance, many mutual funds charge annual management fees north of two percent. And that could significantly eat into the return of an income portfolio.
Other than buying mutual funds, using a financial advisor could also be costly. For an account of $1.0 million, the average annual fee charged by a professional financial advisor is 1.02% of assets under management. (Source: “Financial Advisor Fees | 2017-2018 Report | Complete Details on Average Investment Fees,” Advisory HQ, last accessed May 8, 2018.)
To see how much these fees can cost investors in the long run, let’s take a look at a simple example.
Suppose an investor has a $1.0-million portfolio that grows at a modest rate of five percent per year. After 10 years, the investor would have $1,628,895 in their portfolio—a handsome profit of $628,895.
Now, suppose that investor has to pay one percent in annual investment fees. The fee might go to a financial advisor or a mutual fund manager. In 10 years’ time, that $1.0-million portfolio would grow to $1,480,244.
Return of One Million Dollars Growing at 5% Annually
| Year | No Investment Fee | 1% Investment Fee |
| 0 | $1,000,000 | $1,000,000 |
| 1 | $1,050,000 | $1,040,000 |
| 2 | $1,102,500 | $1,081,600 |
| 3 | $1,157,625 | $1,124,864 |
| 4 | $1,215,506 | $1,169,859 |
| 5 | $1,276,282 | $1,216,653 |
| 6 | $1,340,096 | $1,265,319 |
| 7 | $1,407,100 | $1,315,932 |
| 8 | $1,477,455 | $1,368,569 |
| 9 | $1,551,328 | $1,423,312 |
| 10 | $1,628,895 | $1,480,244 |
Therefore, by paying a measly one-percent investment fee annually, the investor’s return on that $1.0-million portfolio turns out to be $148,651 less than what it would have been without that fee.
Why is there such a big difference?
Well, because when the investor pays that one percent, it’s not just money taking out of their wallet, it’s the money that could otherwise be put into further compounding. For instance, in the first year, the investor paid $10,000 in fees. If there were no fees and that $10,000 was kept in the portfolio, it would keep growing at a five-percent rate compounded every year for that 10-year period.
Of course, I’m not saying that all fees are bad. For someone who doesn’t know anything about stocks, it would certainly be worthwhile for them to talk to a financial advisor. Moreover, if the investment manager can generate substantially higher returns by actively managing a portfolio, the extra return may justify their management fees.
Or, if having someone else managing your money means you can sleep better at night, that peace of mind would most definitely be worth the one-percent investment fee.
However, if you are willing to manage your own portfolio, you should always keep track of the investment costs. It might not be possible to avoid all the investment fees, but you should definitely try to minimize them whenever possible.