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How Fund Expense Ratios Can Impact Your Returns

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It may not have not been reviewed, commissioned or otherwise endorsed by any of our network partners or the Investment company.

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An expense ratio is the ongoing fee you pay to invest in a mutual fund, index fund or exchange-traded fund (ETF). Like with any fee, a fund’s expense ratio reduces your existing assets.

The expense ratio is automatically deducted, rather than charged in an end-of-the-year bill. If you don’t pay attention, you can miss the expense ratio getting taken from your returns. That’s why it’s important to understand expense ratios and know what to look for so you can better minimize their impact on your investments.

What is an expense ratio?

A fund’s expense ratio accrues daily as an annual fixed percentage of your invested assets — for example, 1% or 0.70% of your assets. If you invest in a $1,000 fund with a 1% expense ratio, you would pay $10 for that fund’s expense ratio fees in the first year.

Included in the expense ratio are the costs of running the fund, from operations to administration, with small charges for accounting, legal, custodial or other service costs. If the fund is actively managed, the bulk of the expense ratio will go toward the investment advisory fee. There’s also something called a 12b-1 fee, or distribution fee, which some funds charge to pay for marketing to new investors.

Expense ratio effect on returns

Since the expense ratio is deducted from your assets, it reduces your returns throughout the year and over the fund’s lifetime. Of course, the higher the expense ratio, the bigger the cut it takes.

To get a sense of how much you lose from an expense ratio, let’s consider the number in real dollars. In the example outlined in the table below, let’s say you invest $1,000 into a fund with an average annualized gain of 5%.

A Look at How Expense Ratios Can Impact Your Returns
Year5% gain0.50% expense ratio1% expense ratio2% expense ratio
1$1,050$995$990$980
2$1,103$1,045$1,040$1,029
3$1,158$1,097$1,091$1,080
4$1,216$1,152$1,146$1,134
5$1,276$1,209$1,203$1,191
$ Less-$66.85-$72.93-$85.09
% Less-5.24%-5.71%-6.67%

The 5% gain column is what your balance would be after each year without incurring an expense ratio. The dollar amounts listed under each expense ratio amount indicate what your balance would be after the expense ratio is assessed each year. We also included the dollar amount and percentage loss from the various expense ratios at the bottom of the table.

You also may think of expense ratio effects as a haircut of sorts in your annual performance. If your fund with a 1% expense ratio is up 10%, you will have returns of 9% after paying for the cost of the fund. That may not sound so terrible in good times, but it can be harder to bear in volatile markets — for example, when the fund is down by 10% for the year and you are really down by 11% after fees.

Expense ratios may not be the only factor in your purchasing decision, but they can help you evaluate and compare investment opportunities. Say you have $10,000 to invest and are considering an actively managed mutual fund with a 2% expense ratio to an index fund with a 0.50% expense ratio — here’s how they’d stack up:

InvestmentExpense ratioAnnual cost on $10,000
Active mutual fund2%$200
Passive index fund0.50%$50

Perhaps the more costly mutual fund adds value — enhanced performance returns, steady dividends, risk management — in a way that justifies its higher annual expenses. On the other hand, the mutual fund will have to outperform its benchmark by 1.5% just to keep up with the index fund.

How to find a fund’s expense ratio

The fund’s prospectus: If you’re looking for a fund’s expense ratio, a good place to start is the prospectus, which is a detailed investment overview that funds must file with the U.S. Securities and Exchange Commission (SEC). You can get a printed copy of a prospectus by contacting the fund company directly, and most fund websites include links to digital copies. Or you can find a prospectus on SEC.gov by searching for the name of the fund or fund company. Under the document heading “Annual Operating Expenses,” you can find a breakdown of all of the costs.

Research websites or the fund company or broker: There are also some great websites — including Morningstar, MAXfunds and Kiplinger — that can give you a peek at a fund’s fees and help you compare low-cost options. When purchasing a fund from a broker or fund company, you can ask for a detailed explanation of the fees you will have to pay.

DIY calculations: If you are so inclined, you can calculate a fund’s expense ratio on your own by dividing total operating expenses by the average dollar amount of assets under management (often referred to as AUM).

What’s a good expense ratio?

Knowing how to calculate an expense ratio is one thing. But how do you know whether the expense ratio is good or bad? In general, a good expense ratio is at or around 0.50%. If you want to get more specific, a good expense ratio is one that is at or below the average ratio for a certain fund.

Average Expense Ratios By Fund Type
FundAverage expense ratio in 2019
Equity mutual fund0.52%
Bond mutual fund0.48%
Hybrid mutual fund0.62%
Target date mutual funds0.37%
Money market funds0.25%
Index equity mutual fund0.07%
Index bond mutual fund0.07%
Source: Investment Company Institute

Typically, you want the expense ratio to be as low as possible, so it takes less of a bite out of your investments.

The good news is that average annual expense ratios for mutual funds have been on the long-term decline, falling by over 40% over the past two decades. Part of the reason that expense ratios are declining is to keep up with index funds and exchange-traded funds (ETFs), which tend to have below-average expense ratios, primarily due to lower operating costs and a lack of active management fees.

What’s not included in the expense ratio

There are additional investment fees not listed in the expense ratio that you could face when investing in a fund. Some can be avoided. Here is a rundown of what to look out for.

Shareholder fees

Under the general category of shareholder fees in the prospectus are several potential charges:

  • Sales loads: Some funds are sold through brokers who are compensated by fees paid by investors. These fees are known as loads or sales loads. They might be taken off the top of your investment when you purchase shares in the fund (front-end loads), or you may pay a deferred cost when you take your money out (deferred loads). FINRA limits the sales load on a mutual fund to 8.5%.
  • Redemption fee: This is a transaction cost some funds charge when you redeem your fund shares. It is different from a deferred sales load because the fee does not go toward a broker’s compensation but pays the fund to defray the costs shared by all fund investors when you redeem shares in the fund. The SEC limits redemption fees to a maximum of 2%.
  • Exchange fee: If you exchange one fund’s shares for another, you may owe this fee.
  • Account fee: If there is an account minimum to meet, you may face a fee for falling below it.
  • Purchase fee: This is a transaction cost some funds charge when you purchase shares. Similar to the redemption fee, this differs from a sales load because it pays the fund to defray the shared costs associated with your purchase.

Trading costs

If there is trading going on in the fund, there will be associated broker and transaction costs. In actively managed mutual funds where a lot of trading can occur, these fees can take a toll. If you are buying an ETF, you also should pay attention to the trading costs you pay when buying and selling shares.

Taxes

As the fund buys and sells investments, capital gains and losses are incurred. All fund investors share the tax burden, which is paid for with fund assets. Taxes are a hidden fund cost that can take a toll on your investments.

How to control investing costs

While you can’t dictate a fund’s expense ratio, you can control which funds you choose and how their prices affect your returns. That’s why it’s important to check a fund’s expense ratio and compare it against other potential investments, as well as average prices. That can help you make a decision based on your own financial goals and priorities.

That being said, you should never select an investment simply because it’s cheap, and you may have your own reasons to favor a fund with an expense ratio that is slightly above average. Just keep in mind that the higher the expense ratio, the harder it is to beat or even meet the investment’s benchmark.

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Investing with a Spouse: Joint Accounts or Keep it Separate?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It may not have not been reviewed, commissioned or otherwise endorsed by any of our network partners or the Investment company.

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Like any other type of joint account, joint investment accounts allow you to invest with another person. While you don’t have to be married to commingle your investment activities, there are reasons to consider a joint investment account if you have a spouse.

You can use joint investment accounts to simplify household finances, manage an account on behalf of another or pool resources to make a purchase. There are two main types of joint investment accounts, and each comes with distinct benefits and drawbacks. Before you invest in a joint account, understand how joint ownership works and how it can impact your finances.

How do joint investment accounts work?

Joint investment accounts allow two or more people to invest together. You can invest in just about anything with a partner, including stocks, bonds and funds; property (such as vehicles); or real estate.

Combined ownership in financial assets is referred to as joint tenancy. There are two main types of joint tenant accounts: joint tenants with rights of survivorship and joint tenants in common. The main difference is how the shares are divided should one owner pass away. Each has benefits and drawbacks, depending on your needs.

Types of joint tenant accounts

Type of joint account Joint tenants with rights of survivorship Joint tenants in common
Ownership Each party has equal ownership Parties may have different shares of ownership
What happens in case of owner’s death Interest of deceased is automatically passed on to other surviving owners Interest of deceased goes back to the estate or their beneficiary listed in their will
Probate treatment Avoids probateMay be subject to probate

Joint tenants with rights of survivorship

Joint tenants with rights of survivorship (JTWROS) gives each party equal ownership interest in the overall account. Married couples often choose this type of joint brokerage or banking account because rights of survivorship mean the surviving owner has rights to the deceased’s share. Upon the death of one owner, the assets automatically transfer to the other. However, the JTWROS can be broken before that if one owner decides to leave.

Typically used by:

  • Spouses or couples who want to share investment assets.
  • A parent investing for the benefit of a child.

Pros of JTWROS accounts

  • Keep assets out of probate. Settling a deceased person’s last will through the probate process can be complicated and potentially drag on for months, making it difficult for the surviving spouse to access assets. Some couples strategically place assets in JTWROS to avoid probate. Like other accounts with named beneficiaries, these accounts automatically transfer ownership to the surviving spouse and are typically not included in probate.
  • Everything remains equitable. Both owners of a JTWROS account share the benefits of the assets and repercussions of the liabilities. This mutual self-interest can keep the account from being manipulated by one spouse if things go south in the relationship between account owners.
  • Account owners can leave at will. JTWROS owners must enter into the ownership agreement at the same time. But if one owner wants to leave the investment, a JTWROS can be broken. Both owners’ assets can be sold and equally distributed, or one co-owner can sell their share to another party, changing ownership into a tenancy in common structure (described below).

Cons of JTWROS accounts

  • Surviving owner has control. In the case of one co-owner’s death, full ownership automatically goes to the surviving owner. The surviving party gains full control of the asset, regardless of any contrary instruction in a will or trust.
  • Shared ownership means shared responsibility. If one co-owner is in debt and a creditor comes after the joint assets or freezes the account, both owners stand to lose equally. This is an important consideration, especially when sharing a joint account with a non-spouse. It’s worth noting that in some states, married couples get the same benefits of a JTWROS through something called tenancy by the entirety, but creditors are not able to come after the shared asset.
  • Special taxes may apply. Depending on who you co-own the assets with, how much your assets are worth and other factors, you may face gift or estate taxes on your account. Consult a tax professional to find out what you may be liable for in your specific situation.

Joint tenants in common

Joint tenants in common allows multiple people to share fractional ownership in a property instead of equal ownership. There are no automatic rights of survivorship with joint tenants in common. When one owner dies, their share of the investment automatically goes back to their estate, unless otherwise specified in a will.

Typically used by: Multiple real estate investors who want to share ownership in a single property, and keep the interest of each separate should one party pass away or leave the investment.

Pros of JTIC accounts

  • Clear lines of ownership. With a JTIC, each owner can make decisions independently. Shares of ownership can easily be sold without disrupting the ownership structure, so new owners can be added to the investment at any time.
  • More beneficiary control. Co-owners can specify who will inherit their shares; otherwise, it will automatically go back to the estate upon the death of the owner.

Cons of JTIC accounts

  • May be exposed to probate. If one owner passes away without a will, the shares will likely have to pass through probate and could impact the overall investment.
  • Shared responsibility for debt. When multiple owners sign a mortgage together, all are exposed if the property is foreclosed. If one person stops paying the mortgage, the others may have to cover payments to avoid this.
  • Co-owners can increase uncertainty. If you are investing with outside parties in a JTIC, those parties can choose to sell their shares at any time. If one owner wants out and you can’t agree, they can file an involuntary partition asking a court to divide up the property or sell and split the money.

Should you use joint investment accounts?

As you can tell from the above, the question of whether to open a joint investment account with someone is a complicated one.

A joint tenancy with a spouse is an easy way to share investments, avoid probate and keep the continuity of ownership should one spouse pass away. Joint tenancy ownership with others may make sense depending on the circumstances.

Before sharing ownership of anything, however, it helps to tread carefully and make sure you understand the risks.

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Investing in Stocks: 4 Simple Strategies for How to Pick Them

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It may not have not been reviewed, commissioned or otherwise endorsed by any of our network partners or the Investment company.

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Selecting a stock is not unlike shopping for most big purchases. You research the product, compare it to others for fit, quality, relative value and so on — perhaps compromising in some areas but not in others. Over time, you may become savvy enough to spot value or a prized possession easily.

You can approach stocks by looking to “buy what you know,” but you should also know what you’re buying from an investment standpoint. There are many lenses through which to view stocks, strategies to compare them and ways to hold them. Your goals as an investor can help determine how you analyze and hold stocks.

Here are some essential strategies to help you learn how to pick stocks.

1. Investment styles: Growth, income and value

For some investors, stock picking is all about finding stocks that fit a certain investment style.

Growth investors are looking for the next big thing, and are usually willing to pay a high price for a stock with future potential value. Companies in growth mode are reinvesting earnings and expanding quickly through hiring, new products, acquisitions and capital appreciation. Growth stocks tend to be more aggressive — as more investors drive up the price, it amplifies the risk that they won’t meet growth expectations for their valuation.

Income investors seek companies paying regular income to shareholders in the form of dividends. Even if you don’t need the income now, reinvested dividends function like regular returns that can help grow your investment. Income stocks tend to be found in older, more established firms, which may already be past peak growth years but are profitable and generally well run.

Value investors attempt to find underpriced bargains; that is, companies with underlying value not reflected in the share price. Specifically, they look for stocks with lower price-to-earnings ratios than the overall market, hoping the price will rebound. These are shares of companies that may no longer be in growth mode or may just have fallen out of favor. Value stocks are also more likely to pay dividends.

2. For long-term investors: Fundamental analysis

If you are looking for companies to invest in for an extended period of time, digging into the fundamentals can be a good way to understand its financial health and get to know the stock. Even if you’re not a business whiz, understanding these concepts and tracking them over time can help you compare the stocks of similar companies against one another.

Company fundamentalWhat it isWhat it tells you
Revenue How much money is coming into the company.If the company is growing. Increasing revenue year-over-year is generally a sign of growth, although it doesn’t necessarily mean increased profits.
Earnings per share (EPS)The company’s earnings divided by the total number of shares outstanding. How much of the company’s profits are returned to shareholders.
Price-to-earnings (P/E) ratioThe market value of the stock (or current price) divided by EPS. How much of a multiple investors are willing to pay for a share of the stock. A P/E ratio of 20 to 25 means investors will pay $20 to $25 for every $1 of earnings. High P/E can be a sign the stock will continue to grow or it may be overpriced. Low P/E may indicate a stock is undervalued.
Price/earnings to growth (PEG) ratioThe stock’s P/E ratio divided by expected 12-month growth. If the stock is fairly valued. While P/E ratio doesn’t account for a company’s growth, PEG does. A PEG of one is thought to be fairly valued, greater than one is expensive and less than one is undervalued.
Return on equity (ROE)Net income divided by average shareholder equity (which represents the company’s total assets minus liabilities). How efficient management is at passing earnings on to shareholders. ROE is expressed as a percentage. Investors may tend to stick to a percentage near the S&P 500, which was about 15.6% in 2017.

Many publicly traded companies file annual audited 10-K financials with the Securities and Exchange Commission (SEC), along with quarterly 10-Q updates. In these documents, investors can see a company’s revenue, debt, cash flow management and other metrics. Many financial websites and online brokerage platforms will provide fundamentals as part of their basic stock quote information, as well as access to analyst research and recommendations. Analyst reports often help add qualitative information to your research, such as competition, new products or brand equity.

3. For active investors: Technical analysis

Short-term investors and active traders making bets on what will happen shortly rely on something called technical analysis, which ignores the fundamental value of a stock and instead pays attention to moves in stock price or other types of trading data.

Technical analysis assumes that all information to be known about the stock is built into its price, and prices tend to follow certain repetitive patterns or trends due to investor psychology. These trends may come in the form of tides lasting a year or more, waves lasting one to three months or ripples lasting less than a month.

Investors chart a stock’s trading activity in different ways to uncover certain trend lines and that may be predictors of future moves:

  • Line charts track a stock’s closing price over longer periods, providing a broad view of the stock’s performance.
  • Bar charts give a sense of a stock’s daily movements, or opening price, high price, low price and closing price (OHLC). This view can provide a sense of a stock’s volatility.
  • Candlestick charts are similar to bar charts, with clear illustrations of the stock’s opening and closing prices. If the stock price closes higher than it opens, the difference or “wick” is positive.

A stock experiencing increasingly higher highs and higher lows over time is considered to be on an upward trend, and descending highs and lower lows would signal a downward trend. A sideways trend means that prices have been moving in the same general range. Looking at these charts, investors attempt to find levels of resistance, meaning points at which the stock may stop trending higher, or levels of support, meaning there’s strong enough demand to keep a stock from trending further downward.

Technical analysis can be complicated, which is why many active investors rely on tools offered by online brokers to help spot technical trends.

4. Broad stock picking: Diversified stock portfolios

An easy way to pick stocks is to buy many at once through an exchange-traded fund (ETF). These investments offer mutual fund-like diversification, but they trade like stocks. That means you can buy shares of the Standard & Poor’s 500 or NASDAQ 100 in the same way you might buy shares of Coca-Cola or Apple.

But ETFs come in many other shapes and sizes: You could use a handful of sector ETFs to build a full stock portfolio or balance stock holdings with a bond ETF. Interested in dabbling in commodities, currencies or hedge funds? There are ETFs covering alternative investments as well.

You can purchase ETFs through a broker, which means you might pay a transaction fee when you buy and sell them. Otherwise, ETFs tend to be very low-cost for investors who buy and hold.

Bottom line

Figuring out how to pick stocks seems to be as much about talent as skill, and even the most brilliant stock analysts can’t see around every corner. For the average person, investing in an ETF or mutual fund allows you to own stocks without having to select individual shares. You may not get the same shopper’s high, but there’s also less of a chance you’ll regret your purchase.

If you are determined to own individual stocks, it makes sense to start small and build slowly as your confidence in stock investing grows. You can even start with no money and a completely hypothetical portfolio. There are many stock market simulators online to help you experience stock trading without the risk. Either way, until you understand your appetite for volatility, individual stock investors should only risk excess or “fun money” you can afford to lose.

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