19 August 2017

You're Paying Too Much in Fees

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Our financial lives are littered with fees: for buying a home, hiring an investment adviser, putting money into mutual funds.

We can't escape them. But there are ways to reduce the pain.

Most fees can be reduced, negotiated or eliminated entirely if you are willing to comparison shop and haggle, and it often is worth the extra effort.

Take one stark example: An investor who had $200,000 in a mutual fund would pay $2,500 based on the average annual fee, while the same sum in a broad-stock-market index fund could cost as little as $80. Over 30 years, with fees and returns compounded annually, that gap alone would cost the higher-fee investor about $570,000, if both investments return 8% a year before fees.

In an era of low interest rates, when many investments generate unexciting returns, taking the time to lower your costs can be particularly worthwhile.

Here is how to pay less when you are seeking financial advice, making investments and purchasing a home.

Financial Advice

Advisers at large Wall Street banks typically charge investors around 1% of assets under management a year and provide a variety of services, such as helping clients plan for retirement, choose an appropriate balance of investments and pick individual stocks and funds.

Investors can cut that fee significantly if they accept a little less hand-holding.

Many independent financial advisers will prepare a bare-bones financial plan, including a household budget analysis, a projection of retirement needs and a model portfolio of stocks and bonds, for $500 to $1,500, says Eleanor Blayney, consumer advocate for the Certified Financial Planner Board of Standards in Washington. Those services typically don't include actually managing a client's money.

For an investor with a portfolio of $200,000, that could mean saving $500 or more. And many advisers at Wall Street firms will only work with clients who have $500,000 to $1 million or more to invest.

Investors who want to hire an adviser should meet with at least three candidates, and don't be afraid to ask an adviser to lower fees if a competitor charges less for the same service.

There are other low-fee options. The least-expensive choice is often a fee-only planner who charges by the hour or project. That can work well for an investor who only needs a quick consultation.

Another option: Go virtual.

An array of new firms offers financial advice over the Internet. The firms might not capture the nuances that a traditional adviser would spot in a face-to-face meeting, but they generally charge less.

Discount Brokerages

Stock-trading fees have fallen sharply over the last few decades. In 1991, Charles Schwab charged $74 a trade, according to research by Aite Group, a Boston data firm.

The latest price war started in 2010, as discount brokerages tried to lure back investors who had curtailed trading activity after getting burned by stock-market losses during the financial crisis.

Active investors can still benefit, as prices haven't bounced back up. Currently the average fee per trade is $8.82, according to San Francisco-based NerdWallet.com, which tracks financial firm fees.

Investors who trade infrequently, or who will do most of their trading right after they open an account, should check for promotions that might let them avoid fees altogether.

Mutual Funds and ETFs

Mutual-fund fees have been coming down in recent years. But there is still a big gap between what a typical investor and a cost-conscious investor can pay.

Fees vary greatly, based on a number of factors, including the fund company, the type of asset and the management style.

The average mutual fund had an expense ratio of 1.25% in 2013—or $125 annually per $10,000 invested—down from a peak of 1.47% in 2003, according to Chicago-based investment-researcher Morningstar. But for many types of funds, investors can do much better.

Index funds and ETFs tend to have the lowest fees. When deciding between funds that track the same index, "virtually every time, you should go with the lower cost fund," says Russel Kinnel, who researches funds for Morningstar.

To cut expenses even more, investors might consider ETFs that track slightly obscure indexes that are similar to pricier peers.

For example, an investor might traditionally use an S&P 500 ETF to invest in large-company stocks. However, according to ETF.com, the cheapest large-cap stock ETF is Schwab U.S. Large-Cap, which has an expense ratio of 0.04% and tracks the Dow Jones U.S. Large-Cap Total Stock Market Index. (See the lowest-cost ETFs for various fund categories in the table on this page.)

For ETFs, investors also will want to make sure that the fund's "bid-ask spread" isn't more than three cents for a stock ETF and five cents for a bond ETF. The spread is the difference between the highest price that a buyer will pay and the lowest price at which a seller will sell. A large spread can quickly erase the cost advantage of a low expense ratio.

Actively managed mutual funds tend to carry higher costs than index funds, but investors in active funds also should be careful to limit fees.

Generally, investors shouldn't pay an annual fee of more than 1.25% for U.S. large-company stock funds, more than 1.75% for U.S. small-company stock funds or more than 1.5% for U.S. bond funds, he says. The higher the manager's fee, the harder it will be to beat an index fund, and most managers fail to do so consistently.

To see a mutual fund's expense ratio and how it compares to the average, look up the fund at Morningstar.com and click on the "Expense" tab.

Buying a Home

Home buyers face some fees that typically can't be lowered, such as the fee for a home appraisal.

But they can save thousands of dollars by comparing and negotiating lender fees. And in some cases, paying higher lender fees can actually save money in the long run, if it helps secure a lower interest rate on the mortgage.

Lender fees, also called origination fees, often range from 0% to 1% of the total mortgage amount, says Keith Gumbinger, vice president of mortgage-info website HSH.com.

If a lender isn't charging an origination fee, mortgage applicants should ask for a list of other charges they will likely have to pay at the closing table. Those other charges could more than offset any savings on the origination fee.

In addition, lenders sometimes charge higher fees but offer lower interest rates. That can be a worthwhile trade-off for a borrower who plans to stay in the home for a while.

For example, borrowers who take out a $400,000, 30-year mortgage at a 4.25% fixed interest rate and pay 1%, or $4,000, in fees would need to keep the mortgage for more than 49 months to save money compared with borrowers who pay 4.5% in interest and pay no fees.

Over 30 years, the savings would amount to more than $17,000, after taking into account the $4,000 fee.

To do the math yourself on a fixed-rate loan with an origination fee, consider using a mortgage "amortization" calculator, which breaks out the portion of each monthly payment that goes toward interest charges and the portion that pays down principal. Amortization calculators are available on HSH.com and Bankrate.com.

Sean Agrawal, a marketing executive, recently purchased a three-bedroom condominium in New York's Long Island. He chose to take out a $417,000, 30-year mortgage with a fixed interest rate of 2.75% for 10 years, and pay more than $11,000 in closing costs.

He says that option made more financial sense than another mortgage he was offered that carried a higher interest rate, and would have resulted in just $1,000 in closing costs. "I had to look at the big picture," he says.

But be careful: A higher fee may not always result in a lower mortgage rate. In the Los Angeles area, for example, the lowest rate on a $400,000, 30-year, fixed-rate mortgage without an origination fee was recently 4.13%. Buyers who paid a 1% fee couldn't do any better, according to a survey of lenders by HSH.com.

Many buyers also pay an optional upfront fee to lower the interest rate on their mortgage. Instead, they should find out if they can get the same or a lower rate with another lender at no additional cost by searching mortgage-comparison sites like Bankrate.com and LendingTree.com.

Click here for the original article in the Wall Street Journal.

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