The Newbie Investor's Guide to Fees

New investors often focus on picking the right mix of funds for their portfolios based on their risk tolerance. While choosing the right investments is a key part of building wealth, it’s not the only factor, as there are certain investing costs that you can’t afford to overlook. Before diving in, this is what you need to know about some of the fees you’ll encounter.

For help finding the right investments for your budget, consult a financial advisor about your portfolio.

Transaction Fees

Investment fees fall into two categories: transaction fees and ongoing fees.

Transaction fees apply when you buy or sell assets in your portfolio. For example, if you purchase shares of a specific stock through a broker, you’ll pay them a fee to execute the trade.

Sales Load

Brokers who deal in mutual funds can earn a commission called a sales load. This charge can be a front-end load that you pay when you initially buy the fund, or a back-end load that you pay once you sell the fund. The Financial Industry Regulatory Authority (FINRA) enforces a maximum 8.5% sales load on mutual funds. Certain mutual funds are no-load funds, meaning there’s no sales fee to trade them.

Back-end sales loads shouldn’t be confused with withdrawal fees, which are tacked on when you take non-qualified distributions from a tax-deferred retirement account. For example, if you pull money out of an IRA or 401(k) prior to age 59 1/2, you’d have to pay a 10% early withdrawal penalty, along with regular income tax.

12b-1 Fee

Some funds also carry a 12b-1 fee, also known as a distribution fee. This is an annual fee assessed to cover the cost of marketing and fund distribution. FINRA limits the 12b-1 fees to 10.75% of the fund’s average net assets.

However, not all mutual funds carry this fee, and some of the ones that do roll it into the expense ratio.

Try out our asset allocation calculator.

Ongoing Fees

Ongoing fees maintain your holding in a particular asset.

Advisor Fees

Advisor fees can either be upfront charges or ongoing expenses for investors.

Advisors or brokerage firms charge these fees in return for helping investors choose funds. They are calculated as a percentage of your total investment. For example, if the annual fee is 2% and you have $100,000 in holdings, you will pay your advisor $2,000 a year for their services.

Advisor fees are separate from the account maintenance or custodial fees that certain brokerages charge for managing investment accounts. These charges can either be flat fees or a certain percentage and support expenses like recordkeeping and account reporting.

Expense Ratio

One of the most important expenses new investors need to consider is the expense ratio. Expressed as a percentage, this fee covers the operating costs for a fund on a yearly basis and serves as the easiest way to determine how much a particular investment will cost.

As a general rule, the lower the percentage, the better. By weighing it against the fund’s annual returns, you’ll know how much you stand to profit each year.

The expense ratio is then deducted directly from any earnings on your investments.

Related Article: Investing for Beginners

How Investment Fees Impact Long-Term Returns

Investment fees do not just reduce returns for that year. They also lower the base amount that remains invested.

This, in turn, affects how much money can compound over time. For long-term investors, this compounding effect often matters more than short-term market swings.

Small percentage differences in fees can greatly impact ending portfolio values. For example, a fund charging 0.25% annually versus one charging 1.25% may appear similar at first glance, but over 30 years, the higher-cost option can leave an investor with substantially less, even if both earn the same gross returns.

Fees affect both contributions and growth. When fees are deducted each year, the remaining balance stays invested to generate future returns. This creates a cycle where higher fees continually shrink the portion of your portfolio that could otherwise compound.

Long-term retirement accounts are especially sensitive to fees because of their extended time horizons. Someone who starts investing in their 20s or 30s may pay fees for several decades, which magnifies the impact. Lower ongoing costs can preserve more of each dollar invested.

Fees can also stack up. An investor might pay an advisor fee, account maintenance fee and a fund expense ratio at the same time. Calculating total costs across all fee types will help provide a clearer picture of an investment’s total costs and potential returns.

At the end of the day, comparing costs between similar investments can be just as important as comparing performance. For many investors, it is better to choose low-cost investments that will keep more of your money working toward your long-term goals.

Bottom Line

Newbie investors should always take the time to review total investment costs, including transaction fees, ongoing fees and expense ratios. It is important to understand how they are charged and where to find them, as well as the accompanying tax liability. Always be sure to compare total costs across funds, accounts and advisors. This will help demonstrate how even small fee differences can compound over time, reducing long-term returns. Making these calculations is vital for new investors when building a portfolio to help ensure a profitable start to their investing journey.

Investing Tips

A financial advisor can help you create an investment plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.