Inflation is on the rise, and that means a bigger dent in the real rate of return on your investments. One way to stay a step ahead is taking a closer look at the various fees that can ding your nest egg. Since most people who save in defined contribution plans and individual retirement accounts stash their savings in mutual funds, I’m going to focus on those costs in this post. 

Fees and expenses are related to the costs of managing a mutual fund; marketing it to investors; and sales commission that can occur when you buy or sell a fund. Sometimes the fees are fairly obvious, but some of them are deceptive—you don’t discover them unless you carefully read the fund’s prospectus. Here are a few big fees to examine when looking for a way to boost your investment returns: 

Expense Ratio 

This represents the fund’s total annual operating expenses (including management fees and other expenses) expressed as a percentage of average net assets. If a fund with $100 million in assets charges $1 million to manage the fund, that’s an expense ratio of 1 percent. This money comes right out of the return that would otherwise go into your pocket.

But expensive management doesn’t necessarily correlate with superior returns: Morningstar research shows over the long-term, lower-cost funds outperform those with higher costs. To figure out what a fund costs you every year, take your total investment and multiply by the expense ratio. (You can find the expense ratio at Morningstar.com; pull up your fund’s report and click “fees and expenses.”) Morningstar recommends investors pay no more than 1 percent for a stock fund or bond fund, and no more than 1.5 percent for a small-company or foreign fund.   

To avoid higher expenses, consider an index fund, which tracks the performance of benchmark indices such as the S&P 500. Their expenses are dramatically below those of actively-managed funds – and only 32 percent of actively-managed funds beat the returns of the S&P 500 in 2006, according to Morningstar. 

In a 2007 interview, Warren Buffett called index funds are the best option for investors who don’t have the time to research companies. “Just buy a low-cost index fund and keep buying it regularly over time, because you’ll be buying into a wonderful industry, which in effect is all of American industry,” Buffett said. “If you have 2 percent a year of your funds being eaten up by fees, you’re going to have a hard time matching an index fund in my view.” 

According to data from Lipper Inc., the industry’s average fund expense ratio is 1.27 percent. By contrast, the Fidelity Spartan 500 Index Fund charges an expense ratio of 0.10 percent. The Vanguard Total Market Index Fund charges 0.15 percent.  

A Load or Sales Charge 

This can be a front-end load, charged to pay a broker upfront when you buy the fund; or you can get hit with a back-end load when you sell the fund. There are also level loads that can be charged over a period of years. Look for a no-load fund—but watch out for sneaky funds that call themselves no-load and then whack you with fees disguised under other names, such as purchase fee (which goes to the broker upfront) or redemption fees (charged by the fund when you sell or redeem shares).  

A high load, combined with lofty management fees, can be a disaster for investors.(See this Morningstar story for a look at how investors are getting taken for a ride buying government bond funds from brokers.  

Considering investing in a mutual fund? The Securities and Exchange Commission offers an online Mutual Fund Cost Calculator to help figure out the toll that fees and expenses will take on your investment over time. See www.sec.gov/investor/tools/mfcc/mfcc-int.htm.  

For my Yahoo!Finance column that runs March 20, I interviewed Shoya Zichy, a New York executive coach and trainer, and author of several books on careers. She says your personality not only plays a big role in finding the best job fit, it may determine whether you’ll be underpaid in your career.

Zichy gave me permission to excerpt a test she conducts with her clients:

Take a quick look at the options below.  Choose one from each set of statements.  At least 51% of the time, do you tend to be more:
 
__tactful and diplomatic or __direct and frank?

__apt to avoid conflict where possible  or __apt to meet conflict head on?

__empathetic or __analytical?

__accepting at first or  __skeptical at first?

__apt to take things personally or __objective about criticism? 

Zoya says that if you choose more items from the left column, there’s a high probability you’ll be underpaid by at least 25 percent of your true value. When review time rolled around, you also were less likely to demand a large raise. People who choose from the right tend to earn more than the norm. 

This is due to tactical errors, not personal ones, she emphasizes: “This is not because you lack drive, skills, commitment or talent. Chances are you are simply not asking for your due. When first interviewed, you probably liked the job and/or found compatibility with your future boss and colleagues. So when a reasonable number was offered, you accepted it rather than creating conflict by pushing the envelope and asking for more.” 

Not fighting for higher pay can be devastating over a lifetime of earning. Workers who fail to negotiate a first salary stand to lose more than $500,000 by age 60, according to Linda Babcock and Sara Laschever, authors of Women Don’t Ask: The High Cost of Avoiding Negotiation and Positive Strategies for Change. If this is your situation, Zichy proposes a few solutions:  

-Research salary websites, such as salary.com; look at industry trade magazine surveys and talk to people who are in similar jobs about appropriate compensation levels. When I was switching from print journalism to television, I called friends of friends in that industry, described what I would be doing and asked for ballpark salaries for similar positions. Asking people point-blank what they make is tacky, but there’s nothing wrong with saying, “I have researched this position and heard people make between $50,000 and $80,000. For someone with my experience, would you recommend asking in the low, middle or high end of that range?”

-Set priorities, not only based on salary and bonus but time off, health benefits, technologically advanced equipment, a supportive boss, freedom, and meaningful work. Just because you can’t boost your take-home pay doesn’t mean you can’t increase the value of the overall package, Zichy says.   

-Make a written list of your skills and achievements. Rehearse exactly what you’ll say about what you bring to the table, so you’re confident and focused in your negotiations – and more likely to stand your ground. 

“A lot of people don’t push envelope because they don’t want to upset the relationship with person they are talking to,” says Zichy. “At the end of the day, the company’s chief responsibility is not to you, not matter how much they like you – it’s very rare to find a boss who will fight for a big salary.”  

On March 11, New York’s Columbia University joined the growing number of elite universities that are extending more financial aid to the middle class. According to The New York Times, undergrad from families with annual incomes as high as $60,000 won’t have to pay for tuition, room and board, and other fees, beginning this fall. Yale, Harvard and Stanford have already announced similar moves. 

Don’t let these developments discourage you from saving for college. The best savings vehicle is a state-sponsored 529 plan. The money grows tax-free and can be withdrawn federally tax-free if the money is used for qualified high education expenses such as tuition, room and board and books. Some states, such as New York, also offer an immediate tax break when you put money in their plans. See this site for details on your state’s plan. 

Savings held in 529 plans barely have a minimal effect on financial aid eligibility, according to Mark Kantrowitz, founder of the informational college website finaid.org.  “Regardless of how much the parents earn, amounts in retirement funds, the net home equity, and small businesses owned and controlled by the family are ignored,” Kantrowitz explains.

“Of the remaining assets, the first $45,000 to $50,000 is sheltered, depending on the age of the older parent. The remaining assets are assessed on a bracketed scale, with the top bracket at 5.64 percent,” he says. “So if you save $10,000, the worst case impact is a $564 reduction in aid, leaving you with $9,436 more than you would have had otherwise.” 

Warning: This is a super-long post. But I wanted to try to explain the wonders individual retirement accounts for the people who don’t currently save for their golden years. If your employer doesn’t sponsor a 401(k) or other retirement plan, open and fund an individual retirement account before April 15. Here are some FAQs for the uninitiated:

Who can contribute? Anyone younger than age 70-1/2 who has earned income during the year can put in up to $5,000 in an individual retirement account ($6,000 if you’re over age 50. But you can’t put in more than you actually earned. So if you made $2,000 working part-time, that’s the most you can contribute. The exception is the spousal IRA, for married people who don’t work, and file their tax return jointly. The 2008 income limits are $101,000 to $116,000 for single filers, and $159,000 to $169,000 for married couples filing jointly. (The deadline for a 2008 contribution is before tax day, April 15, 2009.)

Where do I set up my IRA? You can set up an IRA with a variety of organizations—banks, mutual fund companies, life insurance firms, stockbrokers. Consider a mutual fund company that has a reputation for low-cost investments, such as:
Vanguard Group, www.vanguard.com (877) 662-7447
Fidelity Investments, www.fidelity.com (800) 343-3548
Charles Schwab Corp., www.schwab.com (866) 855-9102
T. Rowe Price Group, www.troweprice.com (800) 225-5132

Keep in mind that many fund companies require a minimum IRA investment of $3,000 (at T. Rowe Price it’s $1000). When you set up your account, also set up the “automatic transfer” feature; it allows you to electronically contribute a regular amount every month directly from your checking account.

What should I invest my IRA contribution in? If you are not an avid investor, choose a “life-cycle” “target- strategy” or “age-based” mutual fund, based on the year you plan to retire. It invests your money in a mix of stocks and bonds

What’s the difference between a traditional IRA and a Roth IRA? Money in a traditional IRA grows tax-deferred. That means you don’t pay interest on your investments, or the money you earn on them, until you withdraw the cash in retirement. Contributing to a traditional IRA also reduces your taxable income. Uncle Sam wants to encourage people to save for retirement. For that reason, the money you set aside in a traditional IRA is deducted from the income you report for tax purposes. Let’s say you earn $31,000. You put $3,000 away during the year in your IRA. You subtract that from your gross income ($31,000 – $3,000 = $28,000). As far as Uncle Sam is concerned, you only earned $28,000. This shrinks the amount you have to pay to the government on April 15.

Drawbacks: IRA money is supposed to be for retirement, so if you withdraw your savings before age 59-1/2, you’ll pay a 10 percent penalty and income taxes. However, there are some exceptions to that rule. For instance, you can tap $10,000 of the money penalty-free (one time only) to buy or build your first home, pay for qualified higher education expenses; or pay for big medical bills that aren’t covered by insurance. You can also tap the money if you become disabled. You won’t pay the 10 percent penalty in those cases, but you will have to pay some tax on the money in the year you withdraw it because you didn’t pay any tax on it when you put it in the account.

Also, you have to begin taking something called “required minimum distributions” by age 70-1/2 or Uncle Sam will slap a penalty on you. So it’s not easy to pass an IRA on to your heirs.

When you take the money out of the traditional IRA, you pay ordinary income tax on the money. Why does Uncle Sam wait until you’re retired to tax you? Because, theoretically, you’ll probably be in a lower income tax bracket. As you know, income taxes rise with earnings—the more you make, the more taxes you pay, as a percentage of income. For instance, a single person making less than $29,050 is in the 15 percent tax bracket; the same person making over $146,751 is in the 33 percent tax bracket.

Here’s the whole traditional IRA concept in a nutshell: You put the money away in an IRA tax-deferred while you’re young, carefree, working hard, and making the big bucks. Your big-buck salary vaults you into a higher tax bracket. Your contribute to your IRA helps lower your tax bill every year. Then you become old, carefree, and make the little bucks. Your little bucks drop you into a lower tax bracket, so you pay lower tax on the money you withdraw from your IRA. (The only problem is no one knows if Congress will tinker with tax rates in the future.)

The Roth IRA

The Roth IRA is similar to a traditional IRA in many respects, but if you’re looking for versatility, this is the vehicle you want to drive. The contribution limits are the same as a traditional IRA and the money grows tax-free. (But you can’t contribute to a Roth if your income a certain threshold. Now here’s the big difference: In a Roth IRA, you get no tax break upfront—you pay tax on your contributions now, before you put the money in the account. But you get to withdraw both your contributions — and your earnings on the money — tax-free at age 59-1/2.

Repeat after me: “This is awesome!” Why? Because there are very few vehicles in the world of investing that allow you grow your money and enjoy your profits, completely free of taxes.

Another pro: It’s easier to get your money out of a Roth than a traditional IRA, in the event you need it before retirement. (Although you shouldn’t really think about retirement assets as anything but retirement assets.)

Here’s what you need to keep in mind: There are two components to your retirement savings: the money you put in (contributions) and the interest you earned on that money (profits or earnings). Because you’ve already paid the tax upfront on your contributions, Uncle Sam will let you take them out of your Roth anytime after five years, for any reason, without taxes or penalties. After age 59-1/2, you can take out both contributions and profits tax-free (you must have maintained the account for five years). If you decide to tap the profits from your account before that magic age of 59-1/2, Uncle Sam won’t stop you—but he will slap you with income tax on your profits plus a 10 percent penalty. On the other hand, Uncle Sam recognizes there are legitimate reasons why you may need your profits before age 59-1/2. So he has carved out some exceptions that allow you to take the profits early. You will still pay income tax on the profits, but you can avoid the 10 percent penalty if the money is used:

To put a downpayment on a home (one time only, up to $10,000)
To pay for qualifying college expenses
To pay for big, unreimbursed medical expenses (more than 7.5 percent of your adjusted gross income)
To buy health insurance in the event you are unemployed (you have to be out of work for 12 weeks or more)
If you withdraw a series of equal payments for at least five years until age 59-1/2. (For details on this, see http://www.irs.gov.

 Let’s take an example: Rebecca is 25. She wants to save for retirement and would like to buy a home in a few years. She opens one savings account to save money for her home, as well as a Roth IRA. Rebecca contributes $2,000 a year to her Roth IRA for seven years ($14,000 total). Her investment earns $4,000 in interest. Total account value: $18,000.

By age 32, Rebecca manages to save $7,000 to put down on her house – but it’s not enough. She decides to tap the money in her Roth for a down payment for her first home. With the Roth IRA, she can withdraw all of her contributions—$14,000 (no tax or penalty) — and $4,000 in profits (paying ordinary income tax on them).

If Rebecca had invested in a traditional IRA, she could only withdraw $10,000, and would have to pay ordinary income tax on it. See the flexibility?

As you can see, she has more money available to her by investing in the Roth. Now Rebecca’s a smart gal. She knows she needs that money in her Roth for her retirement. So she only withdraws $10,000 to help cover her house downpayment, and leaves $4,000 in the account to continue growing. Now you might be thinking, what’s the big deal? In one case (the Roth), she paid income tax on the money before she put it in the account. In the other (the traditional IRA), she paid income tax on the money after she took it out.

But here’s why the Roth is superior: Over seven years of working, there is a strong possibility Rebecca’s salary has gone up, putting her in a higher tax bracket. That means she would pay higher taxes on the money she withdraws from the traditional IRA to put down on her home.

Because the Roth is so flexible, it also requires discipline. I would discourage you from using your Roth for anything other than retirement. (Suppose Rebecca loses her job and can’t make her mortgage payments? She would have to sell her home, possibly at a loss, or even wind up in foreclosure. That would mean she not only lost her home, but a big chunk of her retirement savings just went down the toilet, too.)

Now go open your IRA!

Try this financial literacy test, designed by economists Annamaria Lusardi of Dartmouth and Olivia Mitchell of Wharton, to measure competency with more sophisticated financial concepts that are the basis for financial planning and decision-making.  

1. Which of the following statements describes the main function of the stock market? (a) The stock market helps to predict stock earnings; (b) The stock market results in an increase in the price of stocks; (c) The stock market brings people who want to buy stocks together with those who want to sell stocks  

2. Which of the following statements is correct? (a) Once one invests in a mutual fund, one cannot withdraw the money in the first year; (b) Mutual funds can invest in several assets, for example invest in both stocks and bonds; (c) Mutual funds pay a guaranteed rate of return which depends on their past performance 

3. If the interest rate falls, what should happen to bond prices? (a) Rise; (b) Fall; (c) Stay the same 

4. True or false? Buying a company stock usually provides a safer return than a stock mutual fund. (a) True; (b) False  

5. True or false? Stocks are normally riskier than bonds. (a) True; (b) False  

6. Considering a long time period (for example 10 or 20 years), which asset normally gives the highest return? (a) Savings accounts; (b) Bonds; or (c) Stocks 

7. Normally, which asset displays the highest fluctuations over time? (a) Savings accounts, (b) Bonds, (c) Stocks  

8. When an investor spreads his money among different assets, does the risk of losing money: (a) Increase, (b) Decrease (c) Stay the same  The answers are: 1) c; 2) b; 3) a; 4) b; 5) a; 6) c; 7) c; 8 ) b 

Here’s how many respondents in a national survey chose the correct answer: 
1. Main function of the stock market: 76%  
2. Knowledge of mutual funds. 72%
3. Relation between interest rate and bond prices:  37%
4. What is safer: company stock vs. stock mutual fund:  80%
5. Which is riskier, stocks vs bonds:  82%
6. Highest return over long period: 70%
7. Highest fluctuations: 89%
8. Risk diversification 81% 

 In my most recent Yahoo!Finance column, I wrote about America Saves Week, and some of the challenges people face in trying to squirrel away cash for the future. In the comments under the column, a reader suggested that people should instead spend everything they make, because he anticipated hyperinflation in the future. 

I agree that there is trouble on the horizon for the U.S. economy, including higher inflation. But if you think the U.S. is returning to the inflation levels of 1980 – 13.5 percent – then rather than save nothing, it makes more sense to save more, and invest in vehicles that have traditionally offered a hedge against inflation. 

To name a few: Treasury Inflation Protected Securities (or TIPs); defensive stocks, such as consumer staples and pharmaceuticals (or defensive-play mutual funds), that will eventually benefit from rising prices; and commodities, which can be tapped by investing in an exchange traded fund that tracks a commodities index, such as iShares Goldman Sachs Natural Resources Index Fund (IGE).  

Precious metals are another traditional inflation hedge (such as gold mutual funds or gold exchange-traded funds like iShares Comex Gold Trust (IAU). But some pundits think that gold futures, which are up more than 40 percent since last August, may be played out. And there is an ongoing debate about whether gold has provided an effective inflation hedge over time. 

If you believe a hyperinflation scenario is ahead, this would also be a spectacular time to buy a house with a low-interest, fixed-rate mortgage, and stay put. You’ll be paying the same monthly amount in ten years with dollars that are worth less (rather than paying skyrocketing rents).  

On the other hand, inflation has been relatively tame for years. So unless you really believe we’re headed for doomsday — U.S. currency crashes, and we go back to the stone age of bartering – worrying more about inflation than savings is allowing the tail to wag the dog.