The following is a guest post by Chris Holdheide.
Back a few years ago while working in financial services, one of my jobs was to help people plan for their retirement. As a part of that job I was also required to provide a prospectus, which is a document that explains everything about the fund they are buying, and disclose all the fees that were involved with the investment.
However, when it came down to showing people the fees a lot of times I would get this glazed look and no response from the client. In fact less than 9 times out of 10 nobody even bothered to ask me whether the fees were too high or not. So in this article I’m going to show you just how important these fees can be and how much they can cost your retirement if you don’t pay attention to them.
The Types Of Fees
Before I dive in I want to take a quick second and explain a few of the typical fees you will find in a mutual fund:
- Sales Charge. The sales charge is a fee that is paid to the representative who sells the product. Typical sales charges will range from 5% to 6%, this means that for every $100 you invest in your retirement account you are paying the representative $5 to $6. However there are companies that don’t charge the fee at all.
- Annual Fee. The next typical fee is the annual expense fee. This fee is charged to maintain the fund and covers any stocks they might buy and sell within the course of a year.
- 12b-1 Fees. The final fee you might see is a 12b-1 fee. This is a typical junk fee some companies will impose to cover advertising, and promotional literature. It’s best to stay away from this fee as much as possible.
Now that we have an understanding of the kind of fees involved with a typical retirement investment let’s look at what a typical fund may charge. The first fund we are going to look at is American Funds Growth Fund of America. This is a fairly popular fund and has been around for a long time.
If you look at the fund below it shows someone who has invested $20,000 up front, and is earning an 8% return on their account over a 20 year period. This fund charges a 5.75% sales charge, has an annual operating expense fee of 0.69%, and no 12b-1 fees.
By looking at the chart above the fund charged $6831 over a 20 year period and ended up with a total earnings of $76,534. Not bad but now let’s see if we would go with a fund that has lower fees.
In the second example I chose the Vanguard Target Retirement 2055 Fund. This fund carries no sales charge, has an annual operating expense of 0.19%, and no 12b-1 fees. On top of that I’m also showing that it earned an 8% return over a 20 year period as well.
By looking at the chart above we can see that we paid a total of $1765 in fees over a 20 year period and that the fund earned a total return of $89,743. When you compare each fund versus the other we find that by going with Vanguard fund we saved $5066 in fees and on top of that because of the lower fees that Vanguard charged we ended up earning $13,200 more than in our American Funds example..
In the end it’s obvious that Vanguard has the best IRA programs simply because of the lower fees they charge and what they can do for your retirement account for the long term. So what are your thoughts, are low fee IRA companies the best way to go? Feel free to share your thoughts, comments, and questions below.
This article was written by Chris Holdheide a personal finance blogger who writes for Stumble Forward, a blog about helping people avoid financial mistakes, improve their finances, and build wealth.