When most people think of losing money while investing, they probably think of stock market crashes or betting big on the wrong company. These things can definitely hurt your portfolio, but smaller, regular losses can also be hard on your retirement savings over time.
Sometimes, you may not even realize how much you're losing, especially if you're primarily focused on an investment's nominal return -- that is, its return before accounting for taxes, inflation, and investment fees. Here's a closer look at how you might be hurting your savings' growth without even knowing it.
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Investments come at a cost
Investing can make you a lot of money, but it can also come with fees. For retirement savers investing things like mutual funds or exchange-traded funds, you'll probably come across what's known as an expense ratio. This is an annual fee you pay to the team overseeing the fund who manage the assets within it. The expense ratio is usually set as a percentage of your assets invested in the fund.
For example, a fund might have a 1% expense ratio. That means you pay 1% of whatever you have invested in the fund every year. That might not seem like much at first, but with a $10,000 investment, you're already paying $100 per year to the fund managers.
Now, consider how much your investment might grow over the years or decades and how much that can add up to in fees. If your holdings grow to $100,000, you're now paying $1,000 per year. And if you reach an even higher level like $1,000,000, that's a whopping $10,000 per year in fees alone.
Investments can have other fees as well, including sales loads -- a kind of commission to the selling broker -- and 12b-1 fees, which cover the costs of marketing and distributing the funds. Investment fees like these often come directly out of your portfolio, so you may not even realize how much you're paying over time. But it can definitely add up.
How to minimize your investment fees
There's no way to avoid fees entirely when investing, but there are things you can do to reduce how much you owe. The first step is to figure out how much you're actually paying. Your prospectus should include details of the fees associated with your investments. In some cases, like expense ratios, they'll be a percentage of your assets.
Ideally, you want to keep your expenses to 1% of your assets per year or less. If you feel you're paying too much right now, you may want to look at shifting some of your savings to lower-cost investments.
Index funds are a great choice for most people. These funds mimic a market index with the S&P 500 being the most popular. Because the assets in the fund change infrequently, there's less work for fund managers. They pass that on to you in the form of lower fees. Some of the best S&P 500 index funds can have expense ratios of as low as 0.03%. That's just $3 per year for every $10,000 you have invested in the fund. Index funds also diversify your holdings, so the ups and downs of any single stock won't roil your portfolio excessively.
Saving money on investment fees today is definitely valuable, but it's really just the tip of the iceberg. The money you're saving remains invested, so it can grow over time. Over the long run, the money you save on fees could add up to thousands or tens of thousands of dollars that you can put to use during retirement.
