Some years back, there was a great commercial on TV from one of the major financial-services companies that introduced the catchy tag line, "It's not what you earn, it's what you keep." I believe the company was referring to salaries, but this phrase also applies to investing.

Many of us don't understand the expenses associated with investing in, say, a mutual fund, or exactly how much our fund managers or financial advisors are taking home. Some fund managers earn tens or even hundreds of millions per year between their salaries and bonuses, and our financial advisors may be collecting more from us than we realize.

Don't get me wrong -- everyone deserves to get paid. However, we need to know exactly what we're paying them. Don't simply look at the published total returns of a fund while ignoring your personal returns and internal fund costs. What matters most is your return, i.e., what you actually keep!

Mutual funds advertise their return figures at their own discretion, and they sometimes choose to advertise the results of the time frames during which they performed best -- while neglecting to advertise periods of consistent underperformance. Additionally, there's often a lack of transparency when it comes to fund expenses. As an independent investor, you must do your due diligence research before choosing investments.

Total return
When figuring out the return on an investment, it's important to look beyond simple price performance and calculate your total return. Here's the formula:

(current value of investment-contribution) / contribution = total return

Some finance folks will surely jump down my throat because this measure is so crude, but it's a starting point. It gives you a number you can take to your advisor or fund company when you start the conversation about what you're really earning on your investment after expenses. This is sometimes a tough conversation to have, but it's your money, and remember: It's not what you earn, it's what you keep!

Expense ratio
On a fund prospectus or any kind of literature distributed by a fund, you will find a figure labeled "expense ratio," which is the fee investors are charged in order to cover expenses for the fund's operation. The expense ratio is calculated as a percentage of the fund's total assets. There are many parts to this overall fee, including operating costs, administrative costs, management fees, and marketing and distribution fees. For example, if a mutual fund states that its expense ratio is 1.25%, that means that you as the investor will be charged a fee every year equaling 1.25% of the value of your investment in the fund.

Still, the expense ratio may not reflect certain hidden costs. A study at the University of California, Davis was conducted on the investment holdings and transactions of roughly 1,800 investment funds from 1995-2006. The study showed that, on average, "invisible" costs were higher than what was reported through the funds' expense ratios, and were often in excess of 2%. This is one of many reasons investors need to be vigilant.

Commissions
Commissions can account for significant costs on top of the fund's stated expenses. These are fees charged by a broker for each trade that occurs within a fund, and they're not required to be disclosed to investors. To get a better understanding of a fund's trading activity and the impact that may have on added costs, you should pay attention to the fund's portfolio turnover ratio, which measures how frequently assets are bought and sold within a fund. A higher ratio means that fund managers are engaging in frequent buying and selling, which can increase costs and taxes.

Taxes
Another factor that can hinder your returns is taxes. Tax strategies can make the difference between a winning portfolio and a losing portfolio. When dealing with investments in general, it's important to understand short-term versus long-term capital gains and the tax implications of sales. Gains on investments held for on year or less are considered short-term capital gain, and they're taxed as ordinary income. Long-term capital gains taxes apply to investments held for longer than one year and are lower than the ordinary income tax rate. Mutual funds are required to distribute these gains to their account holders every year. This is another area where portfolio turnover ratio is a number to watch: Lots of turnover equates to more taxes that you, the account holder, must pay!

Management style
In general, passively managed funds are less expensive than actively managed funds. A passively managed fund will seek to mirror the performance of an underlying index, which means it requires less management expertise than an actively managed fund with more "hands-on" day-to-day management. While both types of fund management can be appropriate for any type of investment strategy, this is another factor worth weighing when you choose a particular fund.

The Queen of De Nile
A friend of mine recently asked me to analyze her portfolio and tell her if she had enough to retire because her "financial advisor" (an insurance agent) couldn't help her answer that question. His only comment was, "Oh, you'll be fine" (triple yikes!).

As I worked through her investments, I began to see that some of her mutual funds were charging her close to 2% in annual fees, and she had also paid a 5.5% front-end load on these same funds. Fees that high make saving for retirement much more challenging. To give this example teeth, let's just say Dakota invested $100,000 in one of these funds. Over the course of one year she could have been assessed a front-end sales charge of $5,500 and up to $2,000 in expenses, which is 7.5% of her total investment.

I think my friend didn't want to confront her insurance agent and question his choices, so she asked me to act on her behalf. When I inquired, her insurance agent was very defensive; he told me that he, personally, did not "get" any of those fees. The fact is that the company he works for charges her those fees. So, in essence, he does profit from these internal fees, and I'm sure he got at least some of that front-end load. Once again, everyone deserves to get paid for what they do, but the amount should be reasonable.

To my knowledge, Dakota did not speak to her insurance agent about this. She did, however, defend him profusely when we spoke. This brings to light yet another ugly truth of human behavior: We often hate to admit that we, or the people whom we have trusted to act on our behalf, may be doing a poor job. Yes, it's hard on the old ego to say, "Oops! I made a bad choice." But sometimes we have to bite the bullet and make a change -- and the sooner you can correct the situation, the better off you'll be.

In summary, you just have to ask questions and understand what it's costing you to invest, because it's what ends up in your pocket that counts. Everything else is just window dressing! 

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