The main costs of investing, other than taxes (see Rule #6), are transaction charges and management fees. Sometimes transaction costs are obvious, such as the commission on a stock trade. More often, however, they are hidden within mutual fund expenses or in the bid-ask spread on a security. In addition, many mutual funds have up-front commissions of 6% or more, while private placements can cost 9.5% right off the bat.
Then there are ongoing management costs. While there are no direct management fees if you buy your own stocks and bonds, you should impute a value for the time you spend managing your portfolio. If you use mutual funds or separate accounts, management fees and expenses are typically 1.5% per year, plus transaction costs of 0.65%, adding up to 2.15% per year. Some investment products, such as annuities, hedge funds and private placements, have even higher internal costs; 3% or even 4% per year is not unusual.
All these fees subtract from your investment performance. If you don’t keep your investment expenses down, your return after taxes and inflation could easily be negative, even with stocks as your primary investment. Shop around for the best deals, and most important, ask for full disclosure of all fees and expenses whenever you invest.