5 Questions to Ask About Investing Fees

Financial advisors often laud low fees paid on your investment portfolio as the way to achieving higher returns over the long haul.

It's not uncommon to see rates of less than 0.5% for many mutual funds and exchange-traded funds at discount brokerages such as Vanguard, Fidelity, or T. Rowe Price.

But when you invest in a private offering or actively managed product, does it ever make sense to pay higher fees and expenses?

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Experts say that it may, under certain circumstances, though overall, fee-sensitive products are gaining steam in the marketplace with lower ETF pricing, "zero-based expense ratio funds, and more recently, performance-based models in the active management space that properly align fees for the real value..." says Phil DeSantis, head of product management and senior vice president at Westwood Holdings Group in Dallas.

That said, fees alone won't make or break your financial goals or objectives.

"Investors fundamentally need to have the proper asset allocation and managers working for them to perform," DeSantis says.

So the next time you're evaluating investments and their fees, ask yourself the following questions before you either balk or buy:

-- Are fees and expenses appropriate based on performance?

-- Are the investments being privately offered?

-- Are the investments in fluid or complex asset classes?

-- Is the fund manager personally invested?

-- Is the investment niche or themed?

Are Fees and Expenses Appropriate?

For the past several decades, mutual funds and other active investments charged a fixed fee for management, regardless of their performance, but that is slowly beginning to change.

Investors can evaluate an investment -- and how its fees impact it -- by looking at total fees and expenses as a percentage of total or excess returns, and the historical net of fee performance, DeSantis says.

Analyze how much risk a manager is taking by looking at tracking error, information ratio, or standard deviation.

"No two managers are created equal and need to be compared on how much risk they are taking to generate performance," DeSantis says. "This is a critical point when comparing net of fee performance."

You could also look for products specifically advertised or targeted to match investing fees with performance. Westwood recently rolled out a model that aligns performance with fee pricing, instead of traditional fees that "incentivize the asset manager to swing for the fences at the potential expense to the investor," DeSantis says.

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"The investor only pays a fee when we outperform the benchmark," he says.

Are the Investments Privately Offered?

Private offerings are sold by brokers registered with the U.S. Securities and Exchange Commission to accredited investors who meet certain income and net worth requirements. They are not available to the general public and include hedge funds, real estate, or venture capital.

"In many cases, the principals and higher-ups at these firms get paid through management fees of around 2% and then you can expect carry fees up to 20%," says Chane Steiner, CEO of Crediful, an educational personal finance website.

Are the Investments in Fluid or Complex Asset Classes?

Standard fees vary based on the type of portfolio asset, with ETFs indexing to large-caps being about 10 basis points or less, up to 1.75% for specialty ETFs and actively managed mutual funds that require more active, complex strategies in order to optimize returns, DeSantis says.

These could include fluid asset classes such as emerging markets or small company equity funds, says Daniel Kern, chief investment officer at TFC Financial Management in Boston.

"The pace of change in emerging markets, coupled with the wide spread between winning and losing countries and companies lends itself to an active approach to management," Kern says. "The nature of emerging markets indexes has changed dramatically over the past decade, providing risks and opportunities best captured by active managers."

Is the Fund Manager Personally Invested?

"Even if the expense ratio is relatively high, if a fund manager puts a significant percentage of his personal net worth into the fund he is managing then I will seriously consider it because of this commitment," says Steven Jon Kaplan, CEO of True Contrarian Investments in New York.