Exchange-traded funds occupy more space in the investment world because they offer...
by Webster LuptonInvestment Management Fees Explained
We stand by the belief that with a little knowledge and experience, anyone can successfully manage their own investment portfolio. Still, some investors are more comfortable handing over their money to a managed fund or professional investor.
While this route might save you some time and headache, it’s going to cost you. So, before you start throwing money away, it’s important to understand how investment management fees work and whether it’s really a good solution for you. Read on to learn more.
What Are Investment Management Fees?
Investment management fees are collected by mutual funds and investment pros in exchange for managing your portfolio and investments. These fees cover administrative costs, investor relations, stock transactions, analysis work, and compensating managers for their expertise.
Why pay someone to manage your money? The core idea is that by paying an expert, you can get greater returns than you would if you managed your investments yourself. It’s one of those “it takes money to make money” situations. After all, expertise is important, right?
Well, yes and no, but we’ll look at that at the end of the article. First, let’s break down the different types of management fee structures you might encounter.
Types of Investment Management Fees
Investment managers charge clients in a variety of ways depending on the amount invested in the fund, the manager’s performance, or a combination of other factors. Which fee structure you choose will depend on your own investment strategy and goals.
Asset-Based Fees
The most common fee approach is for fund managers to take a percentage of assets under management (AUM). This approach incentivizes managers to make as much money as possible. The more they make for you, the more they get.
The amount charged varies significantly, anywhere from 0.10% to 2% of AUM. Higher fees might reflect a manager’s perceived value, or it might be needed to support a more active trading strategy.
The more the manager trades in search of profit, the more the fund must pay in fees. Funds that passively track indices will usually have lower fees.
Additionally, some managers and funds might also offer a tiered structure where fees are more favorable for those clients with more significant AUM.
Performance Based Fees
Managers might also collect fees based on their ability to outperform a benchmark. This way, you’re only paying for success. A performance-based structure may also include a caveat that requires managers to pay back losses or achieve a minimum return before fees are collected.
While performance fees are effective motivators, this approach might encourage fund managers to take excessive risks. Remember, beating the market reliably over time is extremely difficult to achieve – even for the experts.
Flat Fees
Managers can also charge simple flat rates or per-hour rates for their services. The benefit here is that the investor has predictable fees and can plan accordingly. The downside, of course, is that the manager has little motivation to seek profits and might end up being too conservative.
Hybrid Fee Structures
Hybrid fee structures exist, too. For example, the fee structure might combine asset-based and performance-based approaches where the manager has the opportunity to make extra bonuses if specific thresholds are met while still collecting a baseline fee.
What Affects Investment Management Fees?
Fees vary significantly depending on the type and amount of assets in the fund, the fund’s strategy, the number of clients, and so on. There is no real standard. It’s up to you to examine the details and decide if the fees are worth it.
- Investment Strategy: The more time, effort, and trading required by the strategy, the higher the fees. Aggressively managed funds cost the most due to extensive analysis and trading. Passive funds, exchange-traded funds (ETFs), or robo-advisors tend to cost less.
- Services: If the fund or manager provides extra services like custom portfolios, tax management, and financial advice, fees will increase as well. The more comprehensive the service, the more you’re likely to pay.
- Competition: Competition among investment managers is fierce as the bar for entry is low. Prices can be a race to the bottom sometimes. But then again, do you want to pay rock-bottom prices to the person managing your life savings?
Also, specific strategies such as a focus on sustainable companies or green solutions might cost more as the competition is more limited. - Reputation: Like any product, strong brand names can charge more for the same (or even inferior) results. A handful of companies have brand recognition in the mutual fund world and investment advisor world, which can be leveraged to charge higher fees.
Tips to Minimize Investment Fees
Since we’re in the business of making money, not giving it away, we want to minimize the amount we pay in fees.
Stick to Passive Management
Passively managed funds almost always charge less than actively managed funds because all the overhead of analyzing and trading stocks is reduced. Much of this expensive activity ends up being wasted effort anyway.
Negotiate Fees
You can also negotiate fees if you’re investing a large amount into a fund. Competition among managers is fierce, so if you have a large pot of cash that needs management, you’re in a good position to optimize your fee schedule.
Diversify Fee Structures
Just like you can diversify portfolio assets, you can diversify your investments among different fee structures. Put some money in high-fee, high-return funds and some in low-fee passive funds.
This approach reduces your risk while still gaining some exposure to those geniuses who claim to be able to beat the market.
Read the Fine Print
Carefully check the fund prospectus and other documents for fee information to make sure they’re not sticking you with any extra fees. Remember, it’s a buyer’s market when it comes to investment managers and mutual funds, so do your homework to find the perfect fit.
Are Investment Management Fees Worth It?
The short answer is: it depends – but probably not.
If you have millions and millions in assets, it makes sense to hire a professional money manager or invest in an actively managed fund. Dealing with large amounts of capital and managing all the paperwork to stay legal quickly becomes a full-time job.
It also makes sense to invest in a managed fund if you are truly terrified of the market and want to hand off the entire process to a professional. This way you get the benefits of investment with zero thought or effort required on your part, which is better than not investing at all.
However, for most people, investing in actively-managed mutual funds or paying money managers is a mistake. Remember, the market returns an average of 10% per year. Beating this benchmark is extremely difficult.
Now, not only do managed funds need to beat the market, they need to beat the market plus their management fees. Almost nobody can do this consistently. In fact, actively-managed funds often underperform passive funds, especially when fees are factored in.
Stock prices are essentially random and unpredictable. Nobody has any idea what is going to happen next, regardless of how many graphs and charts they show you.
Don’t Buy the Hype
We hope you have a better understanding of investment management fees, how they work, and how they might affect your own investing goals.
For most investors, the fees aren’t worth it. You’re better off investing in passively-managed ETFs that automatically track stock indices. This is the safest, cheapest, and simplest solution to take advantage of stock market growth.
If you’re ready to start investing on your own, you’ll need a powerful tracking system to keep a close eye on your portfolio. StockMarketEye gives you all the tools you need to manage your portfolio and take control of your financial future.
We offer a 14-day, no-risk trial so you can figure out if our platform is right for you. Check it out today!
