This Fee Can Cost You Hundreds of Thousands of Dollars. Here's How to Avoid It

Protect your hard-earned cash by avoiding these fees.

Recently, finance expert and author Ramit Sethi tweeted out a conversation between two people discussing their investments. His tweet accompanying the conversation warned that many people -- including one of the individuals involved in the discussion -- "never realize they're being ripped off for literally hundreds of thousands of dollars."

So, what was the fee Sethi was talking about, and are you paying it too?

This expense can cost you big time

In the conversation Sethi was commenting on, one of the individuals involved said: "My investment advisor told me it is being managed by a portfolio manager justifying the 2.5% fees."

It was this fee that could end up costing you hundreds of thousands of dollars over the course of your life -- and it is a totally unnecessary expense that virtually no one should be paying.

See, all evidence points to the fact that actively managed portfolios rarely, if ever, outperform passively managed investments like index funds. With actively managed portfolios, people -- presumably investment experts -- pick individual stocks or other investments to buy. With passively managed investments, your money is invested with the goal of mimicking the composition of some type of financial index, such as the S&P 500.

Index funds are much less expensive because there's no person who has to be paid to pick investments. And, historically, index fund investing actually ends up producing higher returns in the vast majority of situations compared with actively-managed funds.

But, some people -- like those who were having the conversation Sethi was talking about -- get talked into choosing an actively managed fund because they believe it will actually net them more money. Unfortunately, even in the rare cases where the investment advisor does pick great stocks and the fund outperforms index funds, the high fees charged end up eating away most of the returns.

Take the 2.5% fee described in the tweet. Let's say you invested $10,000 per year for 30 years and paid that fee each one of those years. You would end up losing $438,851 in fees to your investment manager. That is hundreds of thousands of dollars that could have been in your portfolio but wasn't.

How can you avoid these huge fees?

The good news is, it's not hard to avoid these huge fees. You just need to watch what you are being charged for anything that you invest in.

If you work with a financial advisor who offers you guidance on what to do with your money, try to find a fee-only advisor so their interest will be aligned with yours. An advisor who works on commission has an incentive to try to get you to invest in things that pay that advisor the most rather than to invest in whatever is best for you and your investing goals.

And when you make any investment in your brokerage account, pay attention to the expense ratio. Unless the returns are consistently substantially higher than the 10% average annual returns you could earn from investing in a low-cost S&P 500 index fund, you should steer clear of putting any money into an investment that comes with a high cost.