How Investment Fees Compound Over Time, With the Math
A 1% fee sounds tiny, but it is charged every year on a growing balance. Here is how ongoing fees reduce long-term results, using federal examples.
A fee of half a percent or one percent rarely feels like a decision worth losing sleep over. On a $10,000 balance, 1% is $100 this year. The trouble is that ongoing fees are not charged once. They are charged every year, on a balance that is supposed to be growing, and every dollar taken out as a fee also stops earning a return for the rest of the time you hold the investment. That is compounding working against you.
What an ongoing fee actually is
Most long-term investors pay at least one ongoing fee. For mutual funds and exchange-traded funds, the big one is the expense ratio. The SEC's Investor.gov glossary defines it as the percentage of a fund's average net assets used each year to pay the fund's operating expenses, which can include management fees, distribution or service fees (called 12b-1 fees), acquired fund fees, and other expenses. You will find the number in the fund's prospectus fee table.
Workplace retirement plans can add their own layers. The Department of Labor's guide to 401(k) fees groups them into plan administration fees, investment fees, and individual service fees. You do not write a check for most of these. They are taken out of the account or out of the fund's returns, which makes them easy to overlook.
The Department of Labor's example
The Labor Department's guide gives a clean illustration. Assume you have 35 years until retirement and a current 401(k) balance of $25,000, with no further contributions. If investments return an average of 7% a year and fees reduce that by 0.5%, the account grows to about $227,000. If fees are 1.5% instead, the account grows to only about $163,000. That one-percentage-point difference reduces the ending balance by 28 percent.
Running the same assumptions independently gives $226,556 at a 6.5% net return and $162,846 at a 5.5% net return, a 28.1% gap, which matches the department's rounded figures.
A second example with three fee levels
To see the shape more clearly, take $10,000 invested once, an assumed 6% average annual return before fees, and 30 years of growth with nothing added or withdrawn. The only thing that changes below is the yearly fee.
| Annual fee | Net return | Value after 30 years | Lost to fees vs no fee |
|---|---|---|---|
| 0% | 6.0% | $57,435 | $0 |
| 0.1% | 5.9% | $55,831 | $1,604 |
| 0.5% | 5.5% | $49,840 | $7,595 |
| 1.0% | 5.0% | $43,219 | $14,216 |
The 6% return is an assumption for illustration, not a forecast. Real returns vary year to year and can be negative.
Look at the last column. A 1% fee does not cost 1% of the result. It costs about a quarter of the final value compared with no fee, because each year's fee removes money that would have compounded for every remaining year.
Why the damage grows with time
In year one, a 1% fee on $10,000 is roughly $100. In year 25, the balance is much larger, so the same 1% removes far more dollars. On top of that, every past fee is money that is no longer invested. The Labor Department's guide makes the same point: fees and expenses reduce returns, and the effect builds over a career.
This is also why fees matter most for long horizons. Someone investing for 5 years will notice a fee difference; someone investing for 35 years will feel it in the size of the account at the end.
How to find what you are paying
- Fund documents. The expense ratio appears in the prospectus fee table. Compare it across funds that hold similar investments.
- Plan disclosures. If you are in a 401(k), the plan is required to provide fee information. The Labor Department's guide walks through what to look for and what questions to ask the plan.
- Account statements. Look for administrative or recordkeeping charges deducted directly from your balance.
- Add the layers. An advisory fee on top of fund expense ratios is a second ongoing fee. Total them before comparing options.
A lower fee is not automatically better if it comes with something you do not want, and a fee comparison is only fair between investments with similar risk. But when two options hold essentially the same thing, the cheaper one starts every year ahead.
Key takeaways
- Ongoing fees are charged every year on a growing balance, and money paid in fees stops compounding.
- In the Labor Department's example, a 1.5% fee instead of 0.5% cuts a 35-year ending balance by 28%, from about $227,000 to $163,000.
- On $10,000 at an assumed 6% return for 30 years, a 1% fee leaves $43,219 versus $57,435 with no fee.
- The expense ratio, found in a fund's prospectus fee table, is the main ongoing cost of a fund.
- Add every fee layer, including advisory and plan charges, before comparing options.