November, 2010
By Michael Kalscheur, CFP®
Senior Financial Consultant, Castle Wealth Advisors, LLC

We have always heard the expression, “There is no free lunch,” but there are some things that are provided free of charge. However, are these things really free? Is “free” really the lowest cost option, or is there something even less expensive?

The key is to take into consideration outside costs, such as shipping, travel costs, and fees. You might be surprised that these associated costs are more expensive than the cost of the “free” item you are trying to put your hands on.

For example, which is less expensive, renting a DVD from the library or going to a RedBox kiosk? The library is free, while the kiosk is $1 per movie per night.

For our family, the kiosk is in the local Kroger – just 2 miles away. We are at this Kroger at least once a week anyway, and if I didn’t have time to drop the movie off the next day, my kids could ride their bikes there and drop it off for me. If I drop it off, assuming my car gets around 20 miles to the gallon, it is costing me a 1/10th of a gallon of gas (about $.25) for a grand total of $1.25.

On the other hand, the library is almost 5 miles away, I’m never at the library for anything else, and it’s too far for the kids, so I’d have to make two special trips (one to rent it and one to return it). That’s almost 20 miles for the two round trips. Based on the same gas mileage, I’d spend $2.50 in gas plus all the drive time there and back.

Result – If our family needs one or two movies, it’s more economical (and more convenient) to use a kiosk than the “free” library. Let’s look at another example:

Which is less expensive - No Transaction Fee (NTF) mutual funds or Institutional class shares? If you have an account with Schwab, Fidelity or T.D. Ameritrade, you are probably familiar with “No Transaction Fee” funds on their platforms. These are mutual funds that you can buy and sell without having to pay any commissions or transaction fees.

Institutional class shares are just like the NTF version of the fund; they have the same manager, investment style and holdings. There are really only two differences:

  • Institutional shares have higher minimum investment amounts, perhaps $10,000, $100,000 or $1,000,000. Many times these minimums can be waived if you work with a Registered Investment Advisor (RIA) or other investment professional.
  • The expense ratio (the amount that the manager charges each year to run the fund) is lower. Typically Institutional class shares are 0.25% (25 basis points) less than the NTF fund counterpart.

Custodians will typically charge $25 - $50 to both buy and sell Institutional class shares.

Please Note: Institutional class funds are not the same as “Load” funds, which charge up-front or deferred fees that can exceed 5.75%. That means if you put $5,000 into a load fund, you would pay a $287.50 fee. That is in addition to the annual expense ratio.

Therefore, which is less expensive – the “free” NTF fund or the Institutional class shares? The answer is: it depends on how much you invest.

If you wanted to invest $5,000 in an NTF fund that had an expense ratio of 1%, you would pay $50/year (assuming no growth) via the expense ratio. The Institutional class of the same fund might only be 0.75%, for an annual cost of $37.50. You would save $12.50 per year in internal expenses, but you might pay as much as $100 in transaction fees ($50 to buy and $50 to sell). Therefore, your break-even point is 8 years. Since statistics have shown that the average mutual fund investor holds a fund less than 4 years, the NTF fund would be the best option.

However, what if you were investing $50,000 into that fund? Now the numbers are much different. Annual savings from the lower expense ratio are $125 ($500 - $375). All else being equal, if you held the fund just 10 months you would break even. Everything beyond that would be gravy. Multiply this by your overall portfolio and the savings can easily add up to hundreds, even thousands, of dollars per year.

What is the lesson here? Sometimes “free” can be a very expensive way to buy something. When it comes to your portfolio, look beyond the initial charge and calculate the total cost you are paying. You may be surprised how much your “free” investments are costing you.

Michael Kalscheur, CFP®, is a Senior Financial Consultant at Castle Wealth Advisors, LLC. Castle specializes in helping families and closely-held business owners with strategies to protect and transition family assets from one generation to the next. Castle’s senior partners also work with clients throughout the country in making logical decisions to help them fulfill their personal and business financial goals. For more information visit www.Castle3.com, call 1-888-849-9559 or contact Michael directly at .