Investing on the Cheap
Stashing your money in a bank account or mutual fund costs money. Whether it's loads charged on funds or fees on savings accounts, there are costs and charges in most financial endeavors. And those costs can add up significantly over time, especially for small investors or those just starting out.
And as competition to snag the business of high-net-worth investors gets tougher, brokerage houses and big banks are increasingly courting smaller-scale investors with much shallower pockets.
The added attention they're getting can be dangerous for small investors, however, warns Alan Haft, who heads SH Financial in Boca Raton, Fla. Because they often have less experience with the markets, they may not be paying as much attention as they should to fees, taxes, and performance. It's easy for them to get stung by opting for high-cost managed mutual funds. Brokers tend not to spend much time talking about less expensive alternative investment paths because it's not in their financial interest.
Meanwhile, folks with retail bank accounts can be flummoxed by high fees and hefty minimums imposed on those with smaller balances. What should small investors who aspire to bigger things do? They need to be proactive about finding smarter and cheaper ways to invest and save. This week, "Five for the Money" offers some ideas about how to do it.
1. Get into index funds
One easy way for small investors to keep a lid on costs is to go for index funds instead of managed mutual funds. Not only are the total fees far lower—0.2% to 0.5%, vs. 3% to 5% for managed mutual funds—but the tax consequences are much less onerous, according to Haft at SH Financial.
When there's a lot of volatility in the stock market, exchange-traded funds (ETFs) are a better bet because they trade like individual stocks and allow investors to get in and out of the market on a moment's notice, Haft says. ETFs also enable investors to put stop-losses in place on the downside, which trigger automatic sales when prices are tumbling. Indexed mutual funds are more cost-effective if you plan to systematically invest every month because, unlike with ETFs, you won't be charged transaction fees for putting more money in.
Over time, an index fund will outperform the actively managed mutual fund, Haft says. Factor in lower fees and lower taxes, and index funds are likely to help you earn higher returns without taking more risk.
Within the index-fund arena, it pays to shop carefully. Brokerages may impose management fees on index funds because it's the only way for them to make money on small investors. Vanguard and Fidelity have prepackaged index funds for small investors just starting out—and they don't charge high fees.
2. Get the lowdown on loads
If you opt to go with managed mutual funds, your first decision will be whether to pick front-end vs. back-end, or deferred, sales loads, the fee you pay to buy shares of a mutual fund. Deferred sales loads offer a better deal, as they allow an investor's full $10,000 amount to be put to work instead of skimming the fee off the top at the outset. A 5% up-front sales load, for example, takes $500 off the top, so that only $9,500 is being invested. Deferred sales loads are paid only when you sell your shares back to the fund and funds generally calculate the load based on the value of your investment at redemption.
Another perk you often get with funds that defer the fee is a contingent deferred sales load, or CDSL, which incrementally reduces the sales load to zero, depending on how long you hold the fund. The rate at which this fee diminishes is disclosed in the fund's prospectus. The Securities & Exchange Commission's Web site provides a comprehensive primer on mutual fund fees and expenses.
No-load funds might seem to be the best deal but they often charge other kinds of fees that aren't considered sales loads, including purchase, redemption, exchange, and account fees.
It's essential to check the sales materials when considering a no-load. And don't hesitate to ask questions of the financial professionals or fund-company representatives if you're not sure of the fees and charges that may be involved.
3. Use online tools
A great resource for evaluating a mutual fund's true cost of ownership is Lipper's PersonalFund.com, including transaction and distribution costs, as well as tax implications for fund earnings. The Web site will calculate the amount of income you are giving up through fees based on a series of inputs such as the amount you want to invest and the length of time you plan to hold onto the fund.
Bankrate.com is an objective aggregator of financial rate information on everything from home mortgages to credit cards to car loans to money market and online banking accounts.
4. Seek professional help
One reason to use a financial adviser is to get a "more holistic view of the planning picture than places like Vanguard" provide, says SH Financial's Haft. Advisers take into consideration insurance, estate, and tax planning, and good ones can enforce the rules to ensure that fees are kept low.
If you decide you need a financial professional, approach the task of finding one the way you'd choose a mortgage bank or any other service. In other words, take control. Garrett Planning Network, an online shopping site for finding financial planners, provides a questionnaire to submit to candidates that enables you to compare and better gauge the services you're buying. Questions include: How is the adviser compensated? What kinds of services does he offer? And: Does he provide a written agreement detailing the total amount of compensation and services that he will provide before being hired?
5. Bone up on bank fees
Kathleen Hartman, a financial planner at Greenleaf Financial Group in Indianapolis, recommends that small investors look to credit unions or community banks for cost savings. "Credit unions are closer to a not-for-profit entity than a for-profit entity, and consumers with small balances generally have no annual account fees and low minimums," she wrote in an e-mail message. These venues are also often good places to save on loan costs, she adds.
For those who want to stick with conventional retail banks, she recommends direct deposit for paychecks, as banks "typically reward you for directly depositing your check by waiving minimums and account fees."
Some of the largest retail banks have begun to offer consumers ways to maximize their interest earnings on online savings accounts by linking them to direct payment accounts. This week, HSBC Direct launched an online payment account with an annual percentage yield, or APY, of 2.50% that allows instant fund transfers between online payment and savings accounts that offer an APY of 5.05%.
"Our products are designed to encourage savings," says Michael Prebenda, senior vice-president of HSBC Direct. "It's going to flip the way people would typically manage their cash, encouraging them to keep it in a high-interest savings account. Most people today keep their cash in a checking account, earning little or no interest." HSBC's new payment accounts can be set up for recurring payments and recurring money transfers, "so you never lose control of your money," Prebenda said.