Keeping Investment Costs Low

Okay, admittedly not the most mouthwatering topic to most musicians, but trust me, it's important and easy to understand. What are investment costs? These are the fees that all those vilified Wall St. guys make their living from. If you trade individual stocks, you will pay a stock brokerage fee every time you buy or sell (thus, the broker has an incentive to get you to trade often). If you put your money in mutual funds, an annual fee (called the "expense ratio") will be deducted from your account, and you might pay additional fees (called "loads") whenever you buy or sell shares. Even if you decide to put your money in a "free" savings account at your local bank, they will get their piece of it by offering you a lower interest rate than they are getting when they lend that money back out.

It is reasonable for qualified investment professionals to charge something for their services, especially when they are helping you to monitor your portfolio and choose wisely between different investments. But there is no need to pay exorbitant fees for such services, and many investment advisers are still getting away with charging too much in my opinion. Fees in the range of 1.5% or close to 2% per year are not uncommon among mutual funds and portfolio managers, even at times like this when returns are poor.

1.5% may not sound like much, but over time, fees like that can significantly reduce your returns. For example, let's say you have $10,000 to invest for 10 years:

Mutual Fund A
Expense ratio: 1.5%
Annual gross return: 10%
After 10 years, you'll have: $22,610

Mutual Fund B
Expense ratio: 0.5%
Annual gross return: 10%
After 10 years, you'll have: $24,782

That's $2172 more that you could have collected just by selecting the fund with a lower expense ratio. That's a 9% difference in only 10 years! Notice that both funds had the same results in the market. In reality, different funds will vary in performance, but the funds with higher fees don't necessarily perform better. The only difference here is that one of the funds managed to negotiate a bigger cut for themselves. The difference is magnified further over longer periods of time. Also, this example assumes that neither fund is charging you a load for buying or selling shares. That would reduce your results even more.

Ultimately, it's up to you to pick your investments based on a number of criteria. Investment cost is only one of those considerations. But let me leave you with one final thought: A mutual fund manager overseeing accounts worth $50 million (small by industry standards) will earn $500,000 per year by charging a one percent expense ratio. Isn't that enough?