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The ABC’s of Investment Fees

Ed Hutton, CFAAssistant Professor

Director, Niagara University Financial Markets Laboratoryehutton@niagara.edu

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Before we start…

• This seminar is intended to educate you on how to understand the required fee disclosure now being provided by investment companies. It’s not intended to give a recommendation or an evaluation regarding your personal investment selection or strategy.

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Seattle Seahawks vs. Green Bay Packers

• Did Seattle really win?• NFL Referees locked out by owners over issue

of• Defined Benefit vs. Defined Contribution

Pension Plans!• Defined Contibution-401(k), 403(b) its your

responsibility

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Investment Returns

• Year to year increase in the value of your investment- My XYZ Fund increased by 5% last year; my $1,000 grew to $1,050 (1,000*1.05)

• Compound Return- Each year the investment grows by the investment return multiplied by the new balance. My XYZ Fund grew 5% again last year, so now I have $1,081.50 (1,050*1.03)

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Investment Risk

• The possibility of having a negative or low investment return. My XYZ Fund went down by 10% last year- I went from $1,000 to $900! (1,000 * (1-.1))

• Money Market, least risk-Stocks, most risk• Large Cap, less risk – Small Cap, more risk• Risk can also be called volatility, or B (Beta)

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Risk/Return Tradeoff

• So, why would anyone invest in something with higher risk?

• Higher risk = higher investment return• Factors to consider- Personality type, time

until retirement, other investments

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Investment Fees

• 4 types:– Fund operating expenses: compensation to

investment company for expenses and profits– Marketing Costs: commissions paid to the person

or company you bought the fund from.– Service costs: charges for other services you

decide to buy form the investment company, such as a loan or insurance

– Recordkeeping: Charge paid by your employer for the costs of required paperwork.

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How do you pay these fees?

• Front-End Load: taken out from the amount you are investing I invested 1,000 in ABC Fund, after the 5% load was deducted, I only had an investment of $950.

• Many funds are “No-Load”; no front end load.• Front-End loads reduce the amount you can

accumulate for retirement, since less money is earning an investment return.

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How do you pay these fees?

• Back-End Load (also known as Redemption fee, or deferred sales charge): Deducted from your balance when you withdraw the money.

• Back-end loads may decline over time, and even disappear if you hold fund long enough,

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How do you pay these fees?

• Annual investment fees, also known as annual operating expenses, deducted each year as long as you own your investment.

• Basis Point = 1/100th of a percent; 100 bp is 1%

• Actual Return = Investment Return – Annual Fees

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The Effect of Fees

• 8% investment return, 20 years, $5,000 per year

• High fee: 220 bp; after 20 years total savings equal to $180,022

• Low fee: 40 bp; after 20 years total savings $218,919

• Difference of $38,897

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Are High Fee Funds Worth the Cost?

• If there are special considerations that require a lot of personal attention

• If there is a particular investment strategy you want to implement

• But-• Not if you think that higher fees mean higher

investment returns

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Passive or Active Management?

• Active- Try to find the best stocks to beat the benchmark

• Passive- invest in the stocks in the benchmark, so will always perform at the benchmark level

• Index funds- passive, should always be low cost