Investing BasicsExplainer
How do investment fees affect your returns over time?
A 1% yearly fee sounds small, but over 20 years it can cost tens of thousands of dollars. Learn the main fee types, where to find them and how they compound.
Quick answer
Investment fees come out of your balance every year, so the money paid in fees stops earning anything. The effect compounds: in the SEC's example, $100,000 growing 4% a year for 20 years ends near $208,000 with a 0.25% fee but near $179,000 with a 1% fee.
Key points
- Investors pay two broad kinds of fees: transaction fees when they buy or sell, and ongoing fees every year they own an investment.
- A fund's expense ratio is its total annual operating expenses as a percentage of its assets, and it is listed in the prospectus fee table.
- Because fees come out of the balance each year, they compound: the SEC's 20-year example shows a 1% fee costing about $29,000 more than a 0.25% fee.
- A 5% front-end sales load on a $10,000 purchase takes $500 before anything is invested.
- You can compare fund costs with FINRA's Fund Analyzer and ask any professional directly how they are paid.
What kinds of fees do investors pay?#
The SEC sorts investment costs into two groups[1]. Transaction fees are charged each time you buy or sell: commissions, markups and markdowns, sales loads and surrender charges. Ongoing fees are charged regularly while you own the investment: investment advisory fees, annual fund operating expenses, retirement plan fees and annual variable annuity fees.
Funds add their own layer. The SEC separates shareholder fees, which are charged directly to you, from annual fund operating expenses, which are regular and recurring fund-wide costs paid out of the fund's assets[2]. You never see a bill for the second kind; it is taken out before the fund's return is reported to you.
| Fee | When it is charged | How it usually shows up |
|---|---|---|
| Commission | Each purchase or sale | Shown when you place or confirm a trade |
| Front-end sales load | When you buy fund shares | A percentage taken from your purchase |
| Back-end (deferred) sales load | When you sell fund shares | A percentage taken from what you receive |
| Expense ratio | Every year you own a fund | Deducted inside the fund; reduces its return |
| 12b-1 fee | Every year, as part of the expense ratio | Pays for marketing and selling fund shares |
| Advisory fee | Every year you use an adviser | Set out in your agreement with the adviser |
Fee types from the SEC's fee bulletins[1][2]. Not every product charges every fee.
What is an expense ratio, and how do you read it?#
A fund's total annual fund operating expenses are all of its yearly operating costs combined, which can include management fees, distribution and/or service fees (called 12b-1 fees) and other expenses[3]. Expressed as a percentage of the fund's average net assets, that total is the expense ratio[2]. The 12b-1 part pays for marketing and selling fund shares, such as compensating brokers who sell them[2].
Expense ratios are small percentages, so people often quote them in basis points: one basis point is one hundredth of a percentage point. A 0.25% expense ratio is 25 basis points. See the basis point definition and our full note on expense ratios.
| Expense ratio | In basis points | Yearly cost on $10,000 |
|---|---|---|
| 0.05% | 5 | $5.00 |
| 0.25% | 25 | $25.00 |
| 0.50% | 50 | $50.00 |
| 1.00% | 100 | $100.00 |
First-year cost on a steady $10,000 balance. In later years the dollar cost rises or falls with the balance.
How much can a small yearly fee cost over 20 years?#
More than it looks, because fees and expenses reduce the amount of money in your portfolio that is earning a return[1]. Every dollar taken as a fee this year is a dollar that cannot grow next year, or in any year after. As the SEC puts it, these fees may seem small, but over time they can have a major impact on your portfolio[1].
Worked example
Worked example: the SEC's $100,000 fee comparison, recalculated
Start with $100,000, let it grow 4% a year for 20 years, and take the yearly fee out of the balance after each year's growth. The ending values match the rounded figures in the SEC's bulletin. The 1% fee leaves about $29,200 less than the 0.25% fee, and about $39,900 less than no fee at all.
| Yearly fee | After 10 years | After 20 years | Lost to fees vs no fee |
|---|---|---|---|
| No fee | $148,024 | $219,112 | $0 |
| 0.25% yearly fee | $144,365 | $208,413 | $10,699 |
| 0.50% yearly fee | $140,788 | $198,211 | $20,901 |
| 1.00% yearly fee | $133,871 | $179,213 | $39,899 |
Figures computed in code from the stated inputs; rounded to the nearest cent or tenth.
$100,000 growing 4% a year: 0.25% fee vs 1% fee
The SEC's published figures ($100,000, 20 years, 4% growth)
How do sales loads and one-time charges work?#
A front-end sales load is charged when you buy mutual fund shares; a back-end load is charged when you sell them[2]. The SEC gives a direct example: if you write a $10,000 check for a fund with a 5% front-end load, the load is $500[2]. Only $9,500 is actually invested, so the fund has to earn about 5.3% just to get your balance back to $10,000.
One-time charges are easy to see at the moment of purchase and easy to forget afterwards. Ongoing fees are the opposite: small on any given day and large over decades. Both matter, and the cheapest choice depends on how long you will hold the investment.
Where can you find out what you are paying?#
Read the fee table
A U.S. mutual fund prospectus includes a fee table that lists shareholder fees and annual operating expenses[2]. See how to read a fund prospectus.
Compare funds side by side
The SEC points investors to FINRA's Fund Analyzer to compare the fees and expenses of different mutual funds and ETFs[2].
Ask how the professional is paid
The SEC suggests asking any professional 'How do you get paid?' and reading the firm's Form CRS relationship summary, which includes conversation starters about fees[1].
Add it all up
Combine the fund's expense ratio, any advisory fee and any account fee into one yearly percentage. That total is what your return must beat before you gain anything.
Then run your own numbers with the fee drag calculator. The SEC warns that it can be costly to ignore the fees for buying, owning and selling an investment[4], and this is the step where most of that cost can be avoided.
Why do fees matter more than most people expect?#
Three reasons. First, fees are close to certain while returns are not: a fund charges its expense ratio in good years and bad. Second, fees compound in the opposite direction to returns, exactly as described in our note on compound interest. Third, fees and inflation both come out of the same return. If prices rise 3% a year and you pay 1% in fees, the investment has to earn about 4% a year just to keep its buying power.
None of this means the cheapest product is always the right one. It means cost should be a deliberate part of the choice, compared on the same basis across options, rather than a number you never looked at.
What mistakes do beginners make?#
Judging a fee by its size in one year
A 1% fee on $10,000 is $100 this year. Over 20 years of compounding on a growing balance, the gap between a 1% and a 0.25% fee can reach tens of thousands of dollars.
Comparing returns before fees
Always compare what you keep. Two funds with the same returns before costs can leave very different balances after costs.
Forgetting layered fees
An advisory fee on top of a fund's expense ratio on top of an account fee adds up. Add every layer into one yearly percentage.
Not asking how the seller is paid
Knowing how a professional is paid helps you weigh what they recommend. The SEC suggests asking 'How do you get paid?' directly[1].
What else do beginners ask?#
What is a reasonable expense ratio?
It depends on the type of fund, and there is no single official benchmark. What you can always do is compare similar funds on the same basis using the prospectus fee table or FINRA's Fund Analyzer[2].
Are ETFs free of fees?
Do I pay the expense ratio as a separate bill?
No. It is deducted from the fund's assets, so it reduces the fund's reported return instead of appearing as a charge on your statement. That is why it is easy to overlook.
How do I convert a percentage fee into dollars?
Multiply your balance by the percentage. On $10,000, a 0.25% fee is $25 a year and a 1% fee is $100 a year, before any change in the balance.
What is the bottom line?#
Fees are one of the few parts of investing you can see in advance and largely control. Because they come out of your balance every year, they compound against you just as returns compound for you, and the SEC's own example shows a 0.75-point gap growing into almost $30,000 over 20 years. Find every layer of cost, add it up and compare like with like before you buy.
Sources
Numbers in brackets in the text point here. Grade A = primary source (regulator, statistics agency, law or official document).
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