I suspect that it is very easy to underestimate the difference between paying 1% and 0.1% in yearly fees. Let’s calculate this difference. Moreover, let’s consider other kinds of fees and their impact on a long-term ETF investor.
Classes of fees
When investing, I define 4 classes of fees based on their nature (i.e. how and when they are applied):
- Yearly percentage-based
- One time percentage-based
- Yearly constant
- One time constant
Let’s consider examples for each.
Your financial adviser (fund) takes X% of the money they manage every year as a fee. For funds, this is called Total Expense Ratio (TER).
One time percentage-based
Your broker takes X% of the money during the transaction e.g. when buying or selling ETFs.
Your broker takes X euro each year e.g. as an account management fee.
One time constant
Your broker takes X euro during the transaction e.g. when buying or selling ETFs.
The classes above are ordered based on how badly they can affect you when you invest long-term. Yearly percentage-based fee is the worst offender.
How do you feel when you see 1% yearly fee? Before I started looking into investing, I did consider this cheap and not that important. I speculate that we get conditioned during our life to some scale of numbers, which mostly works in ordinary life situations. E.g. if the price for a bus ticket increases 1%, this would be a minor nuisance. And we naturally use the same logic when we first get to investing. 1% yearly fee - sounds low enough to be ignored.
However, investing is different from ordinary life due to compounding and exponential growth, which we rarely observe otherwise. As a result, our heuristical rules don’t work here.
Let’s consider an example. We invest 1000 euro in two assets (e.g. funds). Both assets have 4% after inflation yearly return, but the first asset has 1% yearly fees, while the second only 0.9%.
After the first year, we will have 1000 * 1.04 = 1040 in both assets before applying the fees. After the fees it is 1040 * 0.99 = 1029.6 in 1% fee asset and 1040 * 0.991 = 1030.64 in 0.9% one. At this stage the difference is only 1.04 euro. However, we are long term investors here and our timeline spans 30-60 years. As a result, we are also missing future returns attached to this 1.04 euro. E.g. with 4% yearly growth, in 30 years it becomes 1.04 * 1.04^30 = 3.37 euro. Please note that the growth is after inflation, so these are today’s euros in terms of inflation. As a result, 1.04 euro we payed in the fees in the future becomes 3.37 inflation adjusted euros, they just don’t go into our pocket (or rather brokerage account) anymore.
At this stage, it still may look like I am crazy. We are discussing here 3.37 euro in the future and losing ~5 euros is not a life changing event. However, this fee is applied each year and the numbers add up. After 30 years, the difference is 69.23 euro (spreadsheet, make a copy if you would like to play with it). This doesn’t look much, but the overall value of your 0.9%-fee investment after 30 years is 2399.4 euro and this difference is 2.88% of the overall value. In other words by choosing 0.9% yearly fee investment instead of 1%, you get 2.88% more money in 30 years (assuming investing only once and 4% after inflation return).
However, investing 1000 euro once is unusual, we all invest monthly instead. What happens in this case? The relative effect of this fee difference decreases, because the later investments have less exposure to the yearly fee. However, since the overall value now is much larger, the absolute effect of the fee is much larger as well. E.g. if we invest 1000 euro every month, after 30 years the difference is 1.61% (8810 euro difference with 548068 total, spreadsheet).
So this is not too bad, right? What is all the fuss about? It is actually pretty bad. Above I took a pretty mild case of 0.9% vs 1%. In real life you can easily get 1% mutual fund yearly fee and 0.1% ETF fee. If you invest 1000 euro once (under same assumptions as above), after 30 years the difference between 1% and 0.1% yearly fee funds values will be 23% (699 euro difference with 3029 total for 0.1% one fund). So going from 1% to 0.1% brings you almost a quarter more money in 30 years. Would anyone here by any chance like to improve your investment return by guaranteed mere 23% in 30 years (equivalent to 0.6% yearly)?
If you invest 1000 euro monthly, the difference is only 13% (85834 euro with 625092 total for 0.1% fund). As a reminder, these are inflation adjusted (i.e. today’s euros). So going from 1% to 0.1% fee fund brings you almost 100k more here. Looks like this is a good compensation for paying attention to fees.
I hope that now 1% yearly fee brings some weird feeling of opposition deep inside you and you immediately imagine 0.1% (or even 0.07%) instead.
One time percentage-based
Now we have considered the elephant in the room (yearly percentage based fees), but there are more ways to lose (or save) money when investing.
Let’s consider one time percentage-based fees. In order to invest you need a broker and all brokers want something in return for their service. Some brokers want a part of the money you invest as a fee for the transaction.
In Germany I often see 0.25% per transaction (e.g. Ing Diba, maxblue). Sometimes brokers have “saving plan” deal and there it can be even larger (0.4% at maxblue). Worth noting that they also have minimal and maximal fees per transaction.
For maxblue the limits are 8.9 and 49.9 if you use normal brokerage and no limits for saving plans. On one hand this is nice for us, because if you decide (for some weird reason) to sell all your ETFs and they are worth 1 million, you will pay not 2500 euro, but just 49.9 euro. Unfortunately, this is the only advantage and how often do you do 1 million transactions these days? On the other hand, the minimal fee penalizes you badly if you buy ETFs monthly (not as badly as yearly percentage fees above, but we like to optimize stuff). E.g. if you buy with 1000 euro, you won’t pay 2.5 euro, but 8.9. If you buy with 100 euro, the situation is even worse - instead of 0.25, you still pay 8.9 (almost 10%, don’t do this).
Thus, when investing moderate amounts monthly, minimal fee affects your return badly. I think the default solution to this is to have a saving plan instead. E.g. for maxblue, you will pay 0.4% of the transaction amount, but only when buying, and 0.25% with 8.9 and 49.9 limits when selling. So when buying for 100 euro, you pay 4 euro instead of 8.9 above. A bit better.
Obviously you have your own unique circumstances, so you should see for yourself what the best way is. My main point here - if there is a one time percentage-based fee, take it into account. E.g. if your broker takes 0.25% without limits for each transaction and you are a long term ETF investor, effectively you are giving away at least 0.5% of all your net worth. If the already familiar feeling of opposition from the previous section didn’t visit you here, please read it again. You pay 0.5% of all your net worth (my feeling of opposition makes me feel bad even to write this). It’s like you take all what you earned in your life and then say - oh, I don’t need this two hundreds part of it, please help yourself my lovely broker. If your working career was 40 years, this is equivalent to you working at least 2.4 months full time just for your broker to pay this fee.
I am also saying “at least” 0.5%. When you buy, you will definitely pay 0.25%. However, when you sell, the fee also affects all the growth of your investment. You could consider this as your net worth as well, but this is definitely more than 0.5% of all the money you invested.
Here you can say - oh, this is all very nice, but what do you suggest? Yeap, we still need a broker to buy and sell, I agree. However, there are brokers who don’t have explicit percentage based fees. E.g. flatex and Onvista (be careful with Onvista, only some account modes (festpreis) don’t have this fee at all, the free buys one has well hidden 0.25% fee when selling). So check your broker and consider switching.
UPD(2020-01-11): Flatex introduces percentage-based account fee (see details and alternatives here). If you were going to choose Flatex, please take this into account.
Please note that percentage based fee per se is not bad. E.g. flatex takes 5.9 per transaction. If you invest 100 euro per month, 0.4% at maxblue will be a better deal for your. Here you should be worried about selling (are you?). As of now, one can theoretically move their assets from one brokerage account to another (even probably for free, but I am not familiar with this topic). Thus, theoretically you can buy all your ETFs at one broker for a very long time and after reaching your financial goals, just move all your assets to another one, where selling is cheaper for you. This also partially protects you against your broker changing their fees (e.g. flatex starting to take 10% instead of 5.9). However, I have no clue whether this applies to saving plans.
I have also said “explicit” above. Technically a broker could try to take a percentage based fees in some other ways (e.g. through spread or poor asset price). I wasn’t able to detect this myself by comparing prices at different brokers and I assume that governmental regulations forbid this (hey, MiFiD and friends).
Ok, easy ones now. Some brokers take some money just for having an account with them (hi, Interactive Brokers). This is likely much cheaper than 0.5% of all your net worth (otherwise, RUN from a broker like that). Still you may take it into account. E.g. for Interactive Brokers it is 10 USD assuming that you have less than 100k USD (or equivalent) with them, so overall 120 USD per year. Not too bad, but spare ~120 USD per year won’t hurt. However, they count your transaction fees against this monthly fee. In other words in the end of the month you pay either 10 USD or all your transaction fees if they are in total larger than 10 USD. So it will be somewhat smaller than 120 USD per year, but not too much if you buy one ETF and only once a month.
Oh, by the way here is a funny fact about Interactive Brokers and percentage based fees. They have a percentage based fee, but it is so low that it may be in the end twice cheaper than flatex’s 5.9 euro. So do your math when choosing a broker!
One time constant
As I already explained above some brokers just take some constant fee for each transaction. I assume that normally you would do 12 transaction per year (+ perhaps 1-5 to rebalance). So with flatex we are talking about ~5.9 * 12 = ~71 euro (this does not take into account stock exchanges fees, but we can’t avoid them anyway). This one has the smallest impact, but you are welcome to take it into account as well.
- Choose funds with low TER. Train your feeling of opposition when seeing 1% yearly fee.
- Consider brokers without percentage based fees transaction fees, but do your math for your specific situation and investing plans.
- If you fancy - take into account broker account fees and constant transaction fees.
Happy low fee investing!