Here's How Fees Can Totally Ruin Your Return on Investment

You may be throwing away tens of thousands of dollars in brokerage fees.

Investing in the stock market can be a great way to build wealth over time. However, there are certain things you need to look out for in order to maximize your return on investment (ROI). One of the most important factors is fees. Even small fees can add up quickly, so it's important to understand how they can significantly affect your ROI.

Fees can add up quickly

A recent tweet by Graham Stephan, a well-known finance expert, noted that a $1,000 investment in Warren Buffett's Berkshire Hathaway in 1965 would have been worth $4.3 million by 2009. If Buffett had set up Berkshire as a hedge fund and charged the typical 2% annual fee plus 20% of any gains, the same investor would have been left with only $300,000, a difference of $4 million!

One of the main reasons why fees are so detrimental is that they can add up quickly. For example, let's say you have a portfolio worth $100,000 and you pay an annual fee of 1% with an annual return of 4%. That may not seem like a lot, but when you factor in compounding effects, the number adds up fast.

Over 20 years, you would pay $28,000 more in fees compared to the same portfolio with fees of 0.25% -- which is nearly 30% of your original investment! If you were able to invest that $28,000, it would have earned an additional $12,000. If your return is 12% per year, the fees will be over $116,000! Fees can make a big difference over time.

Different types of fees

There are several different types of fees that investors should be aware of. The first is known as an expense ratio fee, and it applies mainly to mutual funds and exchange-traded funds (ETFs). This fee covers expenses such as administration costs, management costs, and other operational costs associated with running the fund or ETF. Generally speaking, the average actively managed mutual fund management fee is 0.68%, and fees for index equity ETFs are 0.16%. Expense ratios, however, can be as low as 0.06% to 2%

Another type of fee is 12b-1 fees. This is a marketing fee that many mutual funds charge. It can range from 0.25% to 1%. If you have an advisor, you may either pay a commission or an advisory fee. Advisory fees on average are 1.17% per year. If your advisor receives a commission, the sales charge can vary greatly, and 5.75% isn't unusual.

How to minimize investing fees

The best way to minimize fees is by doing research before investing in any particular asset or fund. Make sure you understand exactly what type of fees are associated with each asset or fund so that you know exactly what you're getting into before investing your hard-earned money.

If you are using an advisor, ask how they are compensated and see if they are willing to reduce your fees. If you are comfortable investing by yourself, consider using a discount online broker, since they typically offer lower fees than traditional brokers do. This can be a good way to save money.

Fees are one aspect of investing that is often overlooked by investors, who tend to focus primarily on potential returns. While some fees may seem insignificant at first glance, they can add up quickly over time, drastically reducing your overall ROI if left unchecked. Fortunately, you can minimize the fees you pay by researching them beforehand and using online discount brokers or free investment apps. If you can minimize the fees you pay, it could mean growing more wealth over the long run.