Investing Fees could cost you your early retirement!

Types of investing fees

When you are investing, there are many different types of investing fees. It is essential to know about them to avoid them.

Of course, there are some fees that you cannot avoid. But you can still minimize them. And some fees are more important than others so you will need to think about them first.

Management Fees

The most important investing fee is the management fee.

Managements fees are something you will pay every year on the stock market funds you are investing in. In funds, this is called the Total Expense Ratio (TER).

The reason this fee is very important is that it is set in % of your invested money. It means that you will lose some percentage of your money year after year. The more money you have, the more fees you are going to pay!

While there are some mutual funds and ETFs with 0% TER, it is still very rare. Therefore, you cannot entirely avoid this tax. But you can minimize it.

Unfortunately, there are some considerable discrepancies between funds and ETFs. For instance, my primary ETF is Vanguard Total World (VT), with a TER of 0.08%. If you take the PostFinance Fonds Global A that invest similarly, it has a TER of 0.80%. This ETF is ten times more expensive!

And you can find even more expensive funds. For instance, another similar fund, the Raiffeisen Global Invest Equity A with 1.32% TER! And the UBS Vitainvest 100 World U is coming at 1.61% TER! This ETF is 20 times more expensive than VT!

By choosing the fund with the lowest TER, you can divide your management fee by twenty! It is a lot of money!

Let’s take a simple example. If you have 100’000 CHF invested in this fund, VT will cost you 80 CHF per year. But with UBS, you will lose 1610 CHF per year! And this is only for one year. The long-term costs are much higher, as we will see shortly. We will see in the next section that this could mean the difference between early retirement and late retirement.

So, you need to minimize management fees! And you need to check these fees. When you choose a fund, a financial service, or a broker, you need to read well about all the fees they may have. Sometimes, they are not transparent, and some fees are hidden. You want to do your research correctly.

Issuance and redemption fees

There is another kind of that you need to be very careful about, issuance and redemption fees!

An issuance fee is a fee that is paid when you buy shares of a mutual fund (or another investment). And a redemption fee is a fee that is paid when you sell shares of a mutual fund (or another investment).

These two fees are generally expressed in percentages. For instance, if you have an issuance fee of 0.2% and a redemption fee of 0.3%, you will pay 2 CHF to buy 1000 CHF of shares and pay 3 CHF to sell 1000 CHF of shares.

Many people believe that these fees are less critical since they are only paid once. This fee indeed has less impact than the management fees. However, they can have a significant impact.

What is essential to know is that there are many funds without any issuance and redemption fees! It means that you can avoid this fee entirely! So, there is no reason to pay an issuance and redemption fee.

Secondly, even a 0.1% fee will weigh you down in the long-term. If you invest 10’000 CHF right now and you directly lose 10 CHF, this means your investment is in negative territory directly. And the issuance fee will also take a cut of your returns. If you sell after ten years and you doubled your investments, you do not want to give away even 0.2% of this!

The great news is: if you invest in ETFs, there are no such things as redemption and issuance fees! And some good mutual funds like Vanguard’s do not have such fees either.

So, you should only choose ETFs or mutual funds with no issuance and redemption fee. And when you are presented with an investment, make sure to check these fees.

In 2020, there is no reason to pay for issuance and redemption fees

Transaction fees

When you invest in the stock market, you will need to use a broker to do so. And broker will introduce an entirely new set of fees: the transaction fees.

Every time you do a transaction on the stock market, you will pay some fees. You will generally pay the same transaction costs when you buy and when you sell.

The differences between brokers can be huge. You can easily find brokers ten times more expensive than others when you invest. For instance, buying 100 shares of Novartis will cost you 5 CHF with Interactive Brokers and 40 CHF with Migros.

And on the U.S. Stock market, the difference is much more significant. Buying 100 shares of Microsoft will cost you 0.36 USD with Interactive Brokers and 80 USD with Swissquote! Swissquote is 200 times more expensive for this trade!

If you are investing every month, like me, these fees can quickly add up to several hundreds of CHF per year. So, you need to be careful.

Custody fees

Sometimes, some brokers will make you pay custody fees. And more likely, some financial services will also make you pay a custody fee.

There are two kinds of custody fees:

1. The custody fees with a fixed amount. While you want to minimize them, they are no so bad unless you are starting up.
2. The custody fees with a percentage. Thes fees are the same as management fees and should be minimized or avoided if possible.

When you choose a broker, you want to avoid custody fees in percentage. For instance, Migros Bank has a custody fee of 0.23% per year. I would never invest with a broker with a percent-based custody fee. The problem is that most people will not even verify this!

When you choose a financial service like a Robo-advisor, you want to select the cheapest one for your needs. These services always have a custody fee. You will not be able to avoid it. But you need to find the one with the lowest fee that fits your needs.

So make sure you are avoiding brokers with custody fees and choosing financial services with low custody fees.

Never invest with a broker with a percent-based custody fee

Taxes

Now, in some countries, you will have to pay taxes on your portfolio. They are not directly investing fees.B ut they will have the same effect. There are are two kinds of taxes that could be important here.

The first important tax is a wealth tax. This kind of tax is based on a percentage of your net wealth. So, the wealth tax has the same effect as a management fee except that you will pay it in cash, and it will not be removed from your portfolio. And Switzerland has a wealth tax, so you need not forget that.

The other important tax is dividend taxes. Since the dividends are a percentage of your net worth, any tax on dividends will also be a percent of your net worth! Once again, this acts in the same way as a management fee. For instance, if you pay 10% taxes on your 2% dividends, this is a 0.2% tax over your entire portfolio. A 0.2% tax is very significant as we are going to see shortly.

The long-term cost of investing fees

Now that we have seen the different fees there is, we can take a look at the long-term impact of the investing fees.

You may think that a few hundreds in fees here and there is not so bad of a deal. But over the long-term, it can make a very significant difference. And you need to be aware of that to motivate you to minimize these fees.

For this, we are going to make a few simple simulations with different management fees. If you have a custody fee in % of your net worth (Robo-advisors, for instance), you can treat it as a management fee. It is important to consider everything together.

I am not going to make simulations with transaction fees and issuance fees because there are too many factors going on. But it will still make a significant difference in the long term! Unless you invest with a stupidly expensive broker, transaction costs do not matter much in the long-term.

And the impact of redemption fees is pretty easy to understand. If you have a redemption fee of 0.3%, you will need to increase your net worth by 0.31% to be financially independent. When you are looking at a 2 million net worth, this is an extra 6200 CHF that you need! But this is not nearly as bad a 0.3% management fee!

For each period, I will do two simulations. For the first one, I will simply take a 5% yearly returns for the simulation. These are somehow reasonable returns to expect.

And, in a second time, I will compute the historical chances of successful retirement with different investing fees. For this, I am going to use the 4% Rule. If you do not know about this, I encourage you to read my article about Trinity Study results. In this article, you will find the details of my simulations.

Impact over 10 years

Let’s start with the impact of fees over ten years. Ten years is a short time for investing.

Here is the evolution of a portfolio starting at 100’000 CHF from 0 to 10 years with different levels of fees.

There is one thing crucial to understand in this graph: the impact of fees becomes greater and greater as more years go by. Most people do not realize this. All the fees you pay do not compound! So, all the fees that you can avoid will compound year after year. Compounding makes a very significant difference.

Most people think they will pay the same amount of fee every year. But if the portfolio gets bigger, so does the fees. So fees also compound if your portfolio compounds! And you lose more money to fees than only the fees you are paying. There is also the lost opportunity of having these fees compound into your portfolio.

Let’s look at how much money you will loose with fees:

With a 100’000 CHF portfolio, you can lose more than 28’000 CHF over ten years to investing fees. 28’000 CHF is a huge amount! A 2.0% fee is very high, but it is not impossible. There are mutual funds out there with such a fee. Do you want to lose 28’000 CHF?

Even a 1.0% fee per year will cost you 14’000 CHF! If you can reduce to a 0.5% fee, you will save more than 7’000 CHF! And this is only for ten years and only for a 100’000 CHF portfolio!

Even over ten years, we can see that investing fees matter! You cannot ignore fees when you are investing in the long-term! You need to think of investing fees like you are thinking of bills.

The analysis of retirement success rate for ten years is not very interesting since even with 2% fees, you still have a 100% chance of success, so let’s keep that for 20 years.

Impact over 20 years

Ideally, you want to invest a longer time. So, let’s see what happens with these investing fees over 20 years.

Over 20 years, the differences between investing fees are much more significant. As your money grows for a longer time, you lose even more to fees. The fees you lose the first year will not compound for the next 19 years. And as your portfolio grows, the fees you are paying are growing higher and higher as well.

So, let’s see exactly how much we are losing to fees:

As you can see, the amount lost to fees is pretty impressive over 20 years! If you pay a 2.0% fee each year, you will have lost 80’000 CHF.  I am sure you can think of better things to do with 80’000 CHF than giving it away!

Over 20 years, the difference between 0.2% and 1.0% fee is already more than 36’000! You do not want to pay anything more than a 1.0% fee!

If you are planning to retire early using the 4% rule (or any other withdrawal rate), you may be interested in knowing how much investing fees could impact your chances of a successful retirement (not running out of money).

I did the simulation for an 80% U.S. stocks portfolio and a 4% withdrawal rate. I am using U.S. inflation here as a reference. Here are the results with different level of investing fees:

Interestingly, investing fees will not have a substantial effect on your chances of success. However, a 2.0% fee will reduce your chances by 5%. A 95% chance of success is still a good result. But let’s keep in mind that this is only for 20 years. 20 years is still a short retirement by any means.

Impact over 30 years

Let’s take a look at the impact of investing fees over 30 years. 30 years is a period that is already more reasonable for early retirement.

Let’s see directly how much money we lose to fees:

After 30 years, a 2.0% fee could cost you almost 200’000 CHF! These amounts are getting extremely significant. It is more money than most people ever save.

By going from a 1.0% fee to a 0.2% fee, you can save over 80’000 CHF! We are talking about a huge amount of money that can make a very significant difference! If you had a portfolio of 1’000’000 to start with, you would get a difference of 800’000 CHF after 30 years!

It is very interesting to note that after 30 years, the lost compounding value is higher than the fees paid. And this gets even more true for a higher number of years!

Let’s check our retirement simulation again for 30 years.

This time the impact of investing fees is significant! A 1.0% fee will cost you more than 10% chances of success. And a 2.0% fee will cost you more than 20% chances!

If you are paying a 1.0% fee or more, you will likely have to use a lower withdrawal rate than 4.0%. When you are planning for the future, it is essential to take this into account. Reducing your chances of success by 10% is already very dangerous. Some people can plan for a 90% chance of success. But many fewer people can accept an 80% chance of success.

Impact on 40 years retirement

Let’s repeat our retirement simulation but for 40 years now. I will not repeat the first experiment since, by now, you should have seen the significant impact of these investing fees.

Over 40 years, investing fees have a devastating impact! Even a 1.0% fee reduces your chances of success to less than 80%! It means that with such a fee, the 4% rule fails! And with 2.0%, your chances of success are even below 60%.

If you are investing in ETFs yourself, it is likely that your investment fees are significantly lower than 1.0%. But even a 0.2% fee diminishes your chance of success by 2.5%. So going from a 0.5% fee to a 0.2% fee will increase your chances of success by 4%. If you are investing with an expensive Robo-advisor, you will have to take this into account if you plan for early retirement.

We can conclude two things at this point:

• Investing fees have a significant impact on your chances of success in retirement if you follow the 4% rule.
• Over a long retirement period, even a small change in fee can have a significant impact.

How to reduce investing fees

We have now seen that investing fees have a significant impact in the long-term. So, let’s a few practical things we can do to reduce them.

Only use ETFs with low TER

The first thing you should do is invest only in cheap ETFs and mutual funds.

If you are in Switzerland, like us, you want to choose only Exchange Traded Funds. Indeed, there are no good mutual funds available in Switzerland. If you are in another country with access to good mutual funds like the ones from Vanguard, you can consider them as well!

When you choose ETFs (or mutual funds), you want to focus on those with a very low Total Expense Ratio (TER). The TER is the management fee per year of the funds. And this will be removed from your net worth year after year. Doing so is the most important thing you can do to reduce your investing fees.

These days, there is never any reason to pay more than 0.5%TER for a fund. And ideally, you want to focus on ETFs with significantly less than that.

Now, the TER should not be the only factor your use to compare ETFs, but it is an important one. I have a guide on choosing Exchange Traded Funds if you need more information.

Use the best broker

Transactions costs are less important than management because they do not represent a portion of your assets.

But this does not mean they are not important either. If every time you invest something, you lose 50 CHF, it is not ideal. And you need to remember that you will also pay transaction costs when you sell your assets.

You especially want to avoid all significant fees that are proportional to the amount invested. But generally, with good brokers, these are so small they almost do not matter.

When you choose a broker, you need to avoid choosing one with a percentage custody fee. Fortunately, there are plenty of good brokers without such fees so that you will never have to pay for it.

But there are other factors at play here. For instance, if you are using a Swiss broker, you will pay up to 0.15% stamp tax duty on each buy and sell operations. This fee is not as bad as a management fee. But this is still something that you want to avoid.

You do not have all the research yourself. I have an article on the best brokers for Swiss investors.

Use the best third pillar

Another place where you will have to pay investing fees is in your third pillar. And again, you want to minimize these fees.

The first thing you want in a third pillar is to have it invested in stocks. Most people do not invest the money in their third pillar. But there are now several good third pillars with a large amount invested into stocks.

To choose between these few good third pillar providers, you need to look at their fees. You will not find something as cheap as a Vanguard ETF. But you can now find third pillars with about 0.5% fee, which is reasonable compared to other alternatives.

If you do not know where to start, read my article about the best third pillar in Switzerland.

Use the cheapest Robo-Advisor

If you are not investing by yourself, you will probably want to use a Robo-Advisor. For this, you will pay a management fee each year.

The price of a Robo-advisor is not the only criteria you should use. However, it is a very important one. As we saw before, the difference in returns is quite significant.

So make sure you are choosing a Robo-advisor with reasonable fees. I have talked about several Robo-advisors in Switzerland. They are not cheap by any means. But there are some more reasonable than others.

Optimize your taxes

We have also seen that taxes can weigh heavily on your fees. There are a few things we can do to reduce this part of the fees.

If you want to reduce your wealth tax, the only thing you can do is move to another state. There are some very significant differences in taxes between the different states. For more information, you can read my post about Geo-Arbitrage in Switzerland. Of course, this is only doable if you are not too attached to your place or if you live close to a border.

There are two ways to reduce your dividend taxes. First, you need to invest in efficient ETFs. Currently, the best ETFs for Swiss investors are U.S. ETFs. It is because you can reclaim 15% of the dividends withheld in the United States.

Secondly, you can avoid investing in companies with high dividend yield and focus on growth. If you want to be diversified, it is impossible to avoid all dividends. But you can avoid investing in funds focused on dividends.

Conclusion

By now, you should understand that investing fees are essential. You cannot ignore investing fees if you are serious about investing!

In the long-term, even a 0.1% extra investing fee will cost you a lot of money. And extreme fees also diminishes your chances of retiring early. Reducing your investing fees should be a priority!

If you realize this, you also realize that you need to minimize fees as much as possible to get the most out of your investments. There is no point investing if most of your earnings are going to your bank, broker, or advisor.

One problem with investing fees is that people do not pay them as bills. If peopled received a 10’000 CHF bill for a 1.0% fee on a one million portfolio, I am sure they would be more eager to optimize it. But investing fees are vicious in that they are almost invisible. So people have a tendency to forget about them.

If you are investing directly by yourself with a broker, the most important thing you should do is invest in ETFs that have a low Total Expense Ratio (TER). Then, you also need to minimize your transaction costs by choosing an affordable broker.

If you are not investing by yourself and you prefer Robo-advisors, you need to make sure you are using the cheapest one that fits your needs. You will pay more in fees than when DIY investing. But investing with a Robo-advisor is much better than not investing at all!

If you do not know where to start, you can start by looking at the best ETF portfolio for Swiss investors.

Did you realize investing fees were so important? Do you know how much fees you are paying?

2020-06-16