Learn how to maximize your retirement savings and passive investment returns by looking at the expense ratio (fees) of your ETFs and mutual funds. Higher-than-needed investment fees could cost you as much as half of your retirement nest egg over your lifetime in lost profits. There will always be some fee involved with investing, but paying more than you need to will substantially decrease the amount you have at retirement.

Investment fees could cost you hundreds of thousands of dollars over your lifetime in lost profits. See how and why, and how to do it better yourself. High fees are not required. You can likely make a better return by investing in super-cost ETFs on your own than you could buying high-cost mutual funds or having someone manage your money (because chances are, they won’t get you a better return than you could on your own with little effort).

In this article I’ll discuss how high fees can hurt you -- and paying 1% per year is very high in some circumstances. So we will look at what high and low actually are. I will also discuss some low-cost ETFs.

Summary Points on ETF and Mutual Fund Fees

• You are paying someone (or a company), likely way too much, to give you returns that are sub-standard.
• A 2% difference in fees could cost you half your retirement over 30 years. Even a 0.5% higher fee could cost you about 25% of your retirement over a long period of time.
• There is an easy option to invest on your own, costing about 0.04% per year. Compare that to 0.7% to 1%, which are also touted as low cost, and you are paying more than 20x as much for the exact same product, year after year. That’s a huge difference and could equate to hundreds of thousands of dollars in lost profits over your lifetime. See the examples below.
• What you could buy, called an Exchange Traded Fund (ETF) is probably exactly what your advisor or mutual fund is buying for 0.04% but then charging you 0.7% or 1.5%. I will discuss what this is in the article.
• This ETF likely has outperformed your advisor or mutual fund every year, and will continue to do so -- because they take their fee. Cut out the fee and your returns go up.
• So if you are a passive buy-and-hold investor, you are likely paying too much and getting too little. Here’s how to change that.

How Much Your Investment Fees Are Costing You

As a passive (buy and hold) investor, which mutual funds or exchange-traded funds (ETFs) you own can have a massive impact on your retirement savings. A 1% per year difference in fees, or even less, can cost you hundreds of thousands of dollars over a few decades. The numbers below illustrate how.

Of course you want to own mutual funds, ETFs, and investments that will go up over time, but you also want to reduce the fees and costs associated with those funds. If two similar investments return 10% in a year, but one charges a 1.5% fee each year while the other charges you 0.4%, the one with the lower fee is obviously a better choice.

With the more expensive ETF/fund you end up with only 8.5% for the year, while the lower fee fund leaves 9.6%. If both funds are essentially the same and are going to produce similar returns year-over-year, then you are far better off switching to the lower fee fund.

As a side note, don’t get suckered into high fee funds. Their results likely haven’t beat the long-term successful track record of the low fee funds discussed below. Compare the historical results before deciding if a higher fee is worth it.

The fee a fund charges is called its expense ratio. For ETFs, you can find it listed on most financial sites. Here is an example from Yahoo Finance. If you own mutual funds, check your statements. The expense ratio should be on there.

It’s Only a 1% or 0.5% Difference. Is My ETF or Mutual Fund Still Too Expensive?

First off, the most expensive ETF I own costs 0.55% to be invested in. I consider this high, but I am willing to pay it because the fund has generated 19.65% average returns per year over the last 10 years. Other funds I own cost 0.04% to 0.08%.

It is quite likely funds you are holding have fees of 1%, 1.5%, or 2%. Some companies, like Wealthsimple charge 0.7% (there are two fees they charge, totaling that).

Even small differences in fees over many years can add up to huge amounts of money. This is because of compounding. If your mutual fund charges you 1% more than a comparable ETF, you aren’t losing out on just 1% per year. You are losing out on the money that 1% could have made, year after year.

Say a fee cost you $100 this year. And next year you make 10% in the fund you are invested in. That $100 that was taken from you would have been worth $110 (had it not been taken). But then they take another $100 for the next year.

In the following year, that original $100 would have been worth $121, the $100 taken last year would have been worth $110 (assuming a 10% rate of return). So over two years you actually lost $231, not just the $200. Add on a few more years and the numbers escalate very quickly.

Let’s look at some examples, assuming an ETF makes 8% per year on average. The average return between 1926 and 2018 for the S&P 500 index is about 10% per year, so 8% per year is a good estimate of what the average S&P 500 ETF can make when investing for the long-term.

0.3% Difference in Expense Ratio

Assume one fund charges you 0.4% and another charges you 0.1% per year. If you deposit $100,000 and let it grow for 30 years at 7.6% (which is 8% less a 0.4% fee), you have $900,260 at retirement. If you get 7.9% (8% less 0.1% fee), you end up with $978,685. You’ve lost $78 thousand for nothing, an amount that is more than most people make in a year. Put another way, you lost $2,600 per year. About $200 per month going into someone else’s pocket, not yours.

And that is only a 0.3% difference. Imagine if the difference is bigger. Maybe you thought you were being nice to your broker by not switching investments for the small fee difference. Does $2,600/year matter to you? Especially when you can likely get better returns by buying a few ETFs yourself and then holding them.

1% Difference in Investment Fees

If someone is charging you 1% or more, you lose much more. $100 thousand invested over 30 years would be worth $995,145 when making 7.96% (8% less a 0.04% fee). That’s an almost 1,000% return over the time period. If someone takes 1% in fees, your return is down to 7% per year, and you end up with $761,226, about a 760% return. You missed out on an extra 240%.

If holding for 35 years, you miss out on 391% and almost $400 thousand. Over 35 years, more than $11,190 was unnecessarily taken from you every year. Are you willing to give up more than $11,000 a year (more if you have more capital)?

And that doesn’t even include additional funds you may add over the years. Making monthly contributions to your retirement savings is recommended. Add in those contributions, which would also compound, and the difference gets even bigger. In some cases, you can see that paying more fees than required could end up costing you half of your potential retirement nest egg.

If you want to do some comparisons yourself, here is an Investment Compounding Calculator Excel spreadsheet where you can play with various numbers and see how various fees and returns could affect you over the years.

Some Investments Are More Expensive Than Others

The point is not the fee itself. Sometimes you pay a higher fee for a certain product because it is more a specialized fund. The point is, compare your ETF and mutual fund fees and returns to other funds. No point giving up percentage points for no reason. It will cost you a lot of money over the long-term.

If you are going to pay a higher fee for a specialized fund, it better be worth it. Make sure the track record justifies the higher cost. If it can’t beat the S&P 500—about 10% per year over many decades—or some other low-cost funds, then invest in the low-cost fund.

Over time, investing in low-cost index funds is a great way to grow wealth -- at least according to Warren Buffett who knows a thing or two about compounding money.

A Simple Non-Expensive Passive Investing Option

If your broker, fund, or ETF isn’t beating the average 10% return of the S&P 500, then you should just be buying an investment that mirrors the S&P 500. The iShares Core S&P 500 ETF (IVV) is one of the cheapest options, costing only 0.03% per year to be invested. The S&P 500 SPDR (SPY) is 0.09%. Small difference, but no point paying the extra fee, as discussed above.

In Canada, the BMO S&P 500 ETF (ZSP) tracks the S&P 500, in Canadian dollars, for a fee of 0.08%. For myself, I don’t make things too complicated when it comes to long-term investing. I contribute to my “self-directed” retirment account monthly and add to my positions by buying more low-cost ETFs, typically the same ones over and over.

The S&P 500 is an index composed of 500 large US companies. ETFs or mutual funds that invest in the S&P 500 are called index funds, because they are tracking or buying the same stocks that are in the S&P 500 index. The company running the index-tracking fund doesn’t need to do much work. There is no research; they just hold the same stocks that are in the index, which is determined by Standard & Poors (S&P).

There are other indexes as well, such as the Nasdaq 100 and the Dow Jones Industrial.

A Bit More Diversification

Owning an index fund, like IVV, SPY, or ZSP is great. Low cost, and the S&P 500 has historically produced solid yearly gains compared to most other benchmarks and fund managers. There will be down years, but historically, over the long run, just buying and holding has produced about 10% per year over very long periods. This is what many mutual funds are doing for you anyway, except they are taking most of the profit in fees.

If you want a bit more diversification, you could also invest in some other global markets. Consider an emerging market fund, China or India fund, or possibly a European fund. You could also consider a commodity fund, although the returns on these vary drastically.

Go through the same process of finding low-cost funds that tend to perform well over time. ETFdb (database) provides return and fee information in tables. Here are the Emerging Markets ones, as an example. An hour of picking a few new ETFs could save you thousands every year going forward.