Many banks and investment companies offer Roth IRAs to clients. Some focus on a certain asset or specialty, such as the ability to heavily trade stocks or offering certificates of deposit. Another popular option is the no-fee Roth IRA.
What is a No-Fee Roth IRA?
A no-fee Roth IRA is a retirement account that a provider markets as having no costs, charges, and other fees associated with it. This is done, quite simply, to attract business. Providers know that once you open a Roth IRA with them, you are not likely to move it in the future.
Unfortunately, despite the name, there is no such thing as a completely fee-free Roth IRA. Providers have expenses and must charge their clients some sort of fee for running the investments inside their retirement accounts. If Roth IRA providers truly charged no fees, they would all go out of business! The no-fee Roth IRA is a marketing tool used to get your attention – and investment dollars.
All the same, there are big differences in the types of fees you will be charged. Individuals interested in a Roth IRA should focus on providers that have the lowest fees for the types of assets and services that match their investing goals.
The 3 Types of Roth IRA Fees
These are the three primary types of fees you can incur with a Roth IRA.
Account Maintenance Fee
Some providers charge an account maintenance fee just to have an account open with them. The company is having you directly pay for some of its overhead expenses. This fee is usually included in the information listed before you open your account, along with the dollar amount you will be charged every month.
If the company targets very specific or exotic types of investments, account maintenance fee may be justified. Generally, though, it is an unnecessary expense.
Stock and ETF Trading Transaction Fees/Commissions
Many Roth IRA providers give you the option to trade stocks and exchange-traded funds (ETFs). Each time you buy or sell an investment, you are charged a transaction fee or commission by the brokerage firm. Fees vary greatly, but most popular providers charge between $5 and $20 per trade. If you’re planning to do a lot of trading in your account, rather than taking a buy-and-hold approach, these fees are especially important.
Mutual Fund Expense Ratios and Loads
Mutual funds are possibly the most common asset held in a Roth IRA. And they can cost you in two ways:
- the expense ratio
- the sales load
How Mutual Fund Expense Ratios Work
Let’s look at the expense ratio first. All mutual funds have expenses that represent the costs of operating the fund. These operational costs are always expressed as a annual percentage of assets invested in the mutual fund; this percentage is known as the fund’s expense ratio. If the fund handles $100 million in assets, and collects $1 million in fees and other expenses, then its expense ratio is 1%.
Unlike a fee, the expense ratio isn’t something directly charged to investors by the Roth IRA provider or billed by the mutual fund management; instead, it is typically paid for out of fund assets. But since they effectively reduce the returns that would’ve been received on those assets, fund investors do pay for these expenses, albeit indirectly.
As a (real-life) example, Vanguard’s S&P 500 Index fund (VFINX) has an expense ratio of 0.14%: in other words, for every dollar invested in the fund, Vanguard keeps 0.14% for its expenses. If you invest $10,000 in this fund, in effect you’ll pay $14 per year to the mutual fund company.
On the whole, mutual fund expense ratios range from as low as 0.25% (usually for passive index funds) to as high as 2% or more for active specialty strategies. The average expense ratio across all mutual funds is about 1.0%. Of course, lower is better–it means more of your investment dollar is actually going into an investment and earning for you.
What Is A Mutual Fund Load?
A fund’s expense ratio represents your cost of owning the fund. In contrast, a load on a mutual fund is a sales fee or commission that is levied on a transaction that involves the fund (i.e., buying or selling shares). And yes, this is a direct charge. Some mutual funds require their investors to pay when they purchase–a front-end load–or when they sell–a back-end load.
The one glaring negative aspect about paying a load, either on the front or back end, is that it eats into returns–and profits. A load of just 1% may not seem like a lot in the grand scheme of things, but it is 1% of your money that is going neither into your pocket nor into your investment. Instead, it is going the mutual fund companies and their coffers. These loads are charged to investors regardless of how the mutual fund performs.
No-Load Mutual Funds
Some mutual funds do not require an investor to pay any sales commission whatsoever; these are called no-load mutual funds. The mutual fund families that charge loads tell their clients that they receive benefits such as superior service, added value, better research and other intangibles. However, with over 8,000 mutual funds out there (the number keeps growing), investors can now often find no-load options with performance records.
Cost of a Mutual Fund Load
So, how much will a load really cost you? Let’s take a hypothetical example.
Let’s say you’re 22 years old, and want to invest $5,000 every year in a mutual fund held in a Roth IRA that charged you a 3% front-end load. Each year, you have $4,850 of your investment working for you instead of the full $5,000, because you lost $150 per year to the load fee. Assuming an 8% rate of return on your investments of $4,850 every year, your nest egg would be worth approximately $1,731,179.42 by the time you reached 65 years old. You would have paid a total of $6,450 in load fees.
That doesn’t sound too bad, right? But, if you had invested in a no-load mutual fund and had the entire $5,000 per year working for you, your nest egg would have been over $1,784,761.41 — a difference of over $50,000!
So, the choice between investing in a mutual fund that charges a load and one that doesn’t should not be taken lightly. As should the whole concept of trying to find a no-fee Roth IRA. A true no-fee Roth IRA may not exist–there’s always going to be some cost somewhere–but you can aim to get as close to it as possible.