What Are Fees in Investing, and How Do They Hurt Returns?

Direct answer

Investing fees are the costs you pay for running a fund, trading, or getting advice. They hurt returns because they are taken from your money every year, in good markets and in bad markets, and because every dollar paid in fees is a dollar that cannot grow for you in later years.

The most important fee for most beginners is the expense ratio. It is the yearly cost of running a mutual fund or an exchange traded fund, shown as a percentage of the money invested in the fund. A fund with a 1.00 percent expense ratio costs 100 dollars a year on a 10,000 dollar balance, while a fund with a 0.10 percent expense ratio costs 10 dollars a year on the same balance. That 90 dollar yearly difference sounds small, but over 30 years it can grow into thousands of dollars, as the worked example below shows.

Fees do not make investing a bad idea. They are part of how funds and advice are paid for. The goal is to know what you are paying, compare funds of the same type, and avoid a high fee for a service you do not need.

What counts as an investing fee?

Not all fees work the same way. Some are taken quietly from the fund, some are charged when you buy or sell, and some are charged by an adviser or a broker. The US Securities and Exchange Commission, in its investor bulletin on mutual fund and ETF fees, groups fund fees into two main categories: annual operating expenses and shareholder fees. It also warns that other costs, such as brokerage commissions, may not appear in the fund fee table at all.

Here are the main fees a beginner is likely to meet.

1. Expense ratio

The expense ratio is the total annual operating expenses of a fund, shown as a percentage of average net assets. It usually includes management fees, distribution or service fees known as 12b-1 fees, and other expenses such as legal, accounting, custodial, and administrative costs.

You do not get a separate bill for it. The fund pays these costs from fund assets, so the value of your shares is lower than it would be without those costs. The fee is charged every year you hold the fund.

Index funds, which aim to follow a market index rather than pick winning stocks, often have lower expense ratios than actively managed funds, which pay a team to research and trade. That does not mean a low fee fund is always better for you, but it is one of the first numbers to compare when two funds do a similar job. Our guide on what an index fund is, and why beginners use it explains that difference in simple terms.

2. Management and advisory fees

A management fee pays the fund adviser for managing the portfolio, and it is usually part of the expense ratio. An advisory fee is different: it is what you pay a financial adviser or a robo adviser for advice and account management, often as a percentage of the assets they manage. That fee is charged on top of fund expense ratios, so always ask for the total cost, not just one layer.

3. Trading commissions and spreads

When you buy or sell a stock or an ETF through a broker, you may pay a commission, often a flat fee per trade. Many brokers now offer zero commission trades for some products, but trading is not free in every case. You may still face a bid ask spread, the small gap between the price a buyer will pay and the price a seller will accept.

For ETFs, the SEC bulletin also notes transaction costs not shown in the prospectus fee table, including brokerage commissions and the difference between the market price of an ETF share and its underlying value, called a premium or a discount to net asset value.

4. Sales loads

A sales load is a commission paid to a broker who sells a mutual fund. A front end load is paid when you buy. The SEC gives a clear example: if you write a 10,000 dollar check to buy a fund with a 5 percent front end load, 500 dollars goes to the selling broker and only 9,500 dollars is actually invested. A back end load, also called a deferred sales charge, is paid when you sell, and it may fall over time if you hold the fund long enough.

A fund that calls itself no load does not charge a sales load, but the SEC is clear that no load does not mean no fees. A no load fund can still charge an expense ratio and other fees that are not sales loads.

5. Account, redemption, and exchange fees

Some funds charge an account fee for maintaining a small account, a redemption fee when you sell shares back to the fund, or an exchange fee when you switch from one fund to another in the same fund family. These fees are usually listed in the prospectus fee table, under shareholder fees. They are easy to miss if you only look at the expense ratio, so check the whole fee table, not just one line.

6. Trading costs inside the fund

The expense ratio does not include every cost of running a fund. When a fund buys and sells stocks or bonds inside it, it pays trading costs of its own. Those costs still reduce returns, even though they are not shown in the expense ratio. A fund that trades very often may have higher trading costs than a fund that trades rarely, even if their expense ratios look similar.

Why a small percentage hurts so much

A fee hurts in three ways at once. First, it is charged every year, not once. A 1 percent fee on 10,000 dollars is 100 dollars in year one, and 200 dollars a year if your balance grows to 20,000 dollars. Second, it is charged from your assets, so it lowers the base that can grow next year. Over decades, the lost growth on fees paid can be larger than the fees themselves. Third, it is charged even when returns are poor, because a fund does not waive its operating costs in a down year. That is why the SEC says a higher cost fund must perform better than a lower cost fund just to give you the same return.

This is the opposite of compound interest working for you. In our guide on how compound interest works, growth builds on growth. Fees work the same way, but in reverse: a cost taken early leaves less money to compound later.

A worked example: the same 10,000 dollars, three fee levels

This is an illustration with simple math, not a prediction. Markets do not grow in a straight line, and no fund guarantees a return. The example uses one lump sum, no extra contributions, and a gross return of 7 percent a year before fees, for 30 years. The net return in each case is the gross return minus the fee, which is a simplification that makes the comparison clear.

Step 1: Start with 10,000 dollars in each case.

Step 2: Apply the net yearly return for 30 years.

• No fee: 7.00 percent a year. 10,000 dollars times 1.07 to the power of 30 equals 76,123 dollars.
• Low fee of 0.10 percent: 6.90 percent a year. 10,000 dollars times 1.069 to the power of 30 equals 74,017 dollars.
• High fee of 1.00 percent: 6.00 percent a year. 10,000 dollars times 1.06 to the power of 30 equals 57,435 dollars.

Step 3: Compare the endings.

• The low fee fund ends 16,582 dollars ahead of the high fee fund, because 74,017 minus 57,435 equals 16,582.
• The no fee case ends 18,688 dollars ahead of the high fee fund, because 76,123 minus 57,435 equals 18,688.
• In year one alone, the difference looks tiny: 10 dollars for the low fee fund against 100 dollars for the high fee fund, on a 10,000 dollar balance. Over 30 years, that 90 dollar yearly gap, plus the lost growth on it, becomes a 16,582 dollar gap.

That is the key lesson. A fee that looks like a rounding error in one year can become a large share of your final balance over a working lifetime. A fund charging 1.00 percent must beat a fund charging 0.10 percent by more than 0.90 percent a year, every year, just to break even for you.

How to find the fees you are paying

Use this short checklist, once a year, and before you buy a new fund.

1. Find the prospectus fee table. Search for annual fund operating expenses and shareholder fees. The total annual fund operating expenses line is the expense ratio.
2. Write down the expense ratio as a dollar amount. Multiply your balance by the ratio: 10,000 dollars times 0.0010 equals 10 dollars for a 0.10 percent fund, and 10,000 dollars times 0.01 equals 100 dollars for a 1.00 percent fund.
3. Check for loads and account fees in the shareholder fees section. A front end load reduces the amount actually invested from day one.
4. Ask about adviser fees separately, including whether they sit on top of fund fees and what service they cover.
5. Compare funds that do the same job, and use the same amount and holding period for each fund. A low fee alone does not tell you whether a fund fits your goal or your risk level. Our guide on what risk in investing means, in simple terms can help you judge that side separately.
6. Use a comparison tool such as FINRA’s Fund Analyzer, named in the SEC bulletin, to compare mutual fund and ETF fees.
7. Check the net expense ratio, not only the gross ratio. A fee waiver may end, so check the prospectus for the waiver end date.

If you cannot find a fee, ask the fund company or your broker in writing.

When a higher fee might be worth it

A higher fee is not always a mistake. You might reasonably pay more for personal advice, for a fund that holds a hard to access market, or for a service that saves you time and mistakes. Ask whether the extra service is worth the extra cost, in dollars, over the years you will hold it.

A higher fee is harder to justify when a fund does almost the same job as a much cheaper fund, when you are paying two layers of fees without realising it, or when you are paying a sales load for a fund you could buy without one. Watch flat fees on small accounts too: a 25 dollar yearly account fee is 2.50 percent on a 1,000 dollar account, but only 0.25 percent on a 10,000 dollar account.

Do not switch funds only because a fee is lower. Check the fund goal, the risk, and any exit fee or load you would pay to switch. If you are investing through a retirement account, our guide on what a retirement account is, in simple terms explains why the account type matters as well as the fund.

Common mistakes to avoid: thinking no load means no cost, comparing only the percentage and never the dollars, ignoring stacked adviser and fund fees, trading often to chase performance, and assuming a high fee means a better fund. Past performance does not guarantee future results.

What to do next

Start with the fund you already own, if you own one. Look up its expense ratio today, turn it into a dollar amount on your balance, and write that number down. Then compare it with a similar fund with a lower expense ratio, using the same amount and time period. You do not need to act today, but you do need to know the number.

If you are just starting, read our guide on how much money you need to start investing and our guide on what an ETF is, and how it is different from a stock. Then compare expense ratios side by side, and check for loads before you buy. Our guide on how stocks, bonds, and funds work together shows where a fund fits in a simple portfolio.

Fees are not the whole story of investing, but they are the part you can control most clearly. Returns are uncertain. Fees are certain, charged every year, and they compound. Keeping them low, where the service is the same, leaves more of your money working for you.

Frequently asked questions

What is an expense ratio in simple terms?

An expense ratio is the yearly cost of running a fund, shown as a percentage of the money in the fund. A 0.10 percent ratio costs 10 dollars a year on 10,000 dollars, and a 1.00 percent ratio costs 100 dollars a year on the same amount. The fund takes the cost from fund assets, so you do not receive a separate bill.

How do fees hurt investment returns?

Fees reduce the base that can grow in later years. A higher cost fund must earn more than a lower cost fund just to give you the same return, and the gap grows because money paid in fees cannot compound for you.

Is a low fee fund always better?

No. A low fee is a strong starting point when two funds do a similar job, but also check the fund goal, the risk, the holdings, and any other fees. A cheap fund that does not fit your goal is not a good deal.

What is the difference between an expense ratio and an advisory fee?

An expense ratio is charged by the fund for running the fund. An advisory fee is charged by an adviser for advice and account management. You can pay both at once, so ask for the total cost.

Do I pay fees if my investment goes down?

Yes, in most cases. Operating expenses are charged from fund assets each year, whether the market goes up or down.

Where can I check a fund’s fees?

Check the prospectus fee table and the fund shareholder reports, and use a comparison tool such as FINRA’s Fund Analyzer to compare funds on the same amount and time period.

Conclusion

Investing fees are the price of running funds, trading, and getting advice. The expense ratio is the fee most beginners should learn first, because it is charged every year from fund assets and it compounds against you over time. On 10,000 dollars over 30 years at a 7 percent gross return, the illustration in this post ends 16,582 dollars apart between a 0.10 percent and a 1.00 percent fee. Learn your fee, turn it into dollars, compare similar funds, and check for loads and stacked adviser fees before you buy.

Disclaimer: This article is for education only. It is not financial advice, and it does not guarantee any result. Your income, costs, debts, and goals are personal, and you should consider your own situation, and speak to a qualified professional if you need personal advice, before making a financial decision.