How important are fees to your retirement plan’s success? As Vanguard founder John Bogle pointed out in a recent discussion with analysts, it’s really all that matters.

Fees easily wipe out a huge portion of the yield on stocks, he said, more than 63% of  your money.

That’s the real danger to retirement savers, especially folks over 45. With fewer years of work ahead to save and compound, every penny counts. Fees are fixed costs that are consciously structured to suck money from your accounts, regardless of performance.

Nothing about stocks is guaranteed. Yet research shows that stocks have provided an annualized return of between 6.5% and 7% after inflation, well above other investment types.

The reason for that superior number is simple enough: reinvested dividends. Companies recognize the role of investors as owners and give them cash income in the form of a dividend.

Retirement savers who reinvest those dividends end up with far more money, a compounding effect that accelerates over the years. It’s how reliable retirements are built.

But what if you don’t get to reinvest your money? What if someone else keeps it?

That’s Bogle’s simple point: If stock dividends average 1.9% and the average mutual fund charges its investors 1.2%, then the investor is left with just 0.7% in net yield to reinvest. “We eat up all of our dividends with stock expenses,” Bogle said, and the “industry you could easily say doesn’t give a damn.”

In short, there are two certainties in your retirement plan: Income from stocks and bonds and the level of fees you pay. Since most managers can’t beat the market after deducting their fees, your best shot at retiring well is to secure a market return and consistently reinvest the dividends.

Assume for a moment that you get no joy from the markets. Your investments are flat for 12 months straight. In reality, you did collect income. In a straight S&P 500 Index investment, that’s the 1.9% dividend yield Bogle mentions.

The other certainty, then, is the fees. Subtract those and you’re down to 0.7%. It’s not a maybe. Brokerage-based investment advisors and mutual fund managers will take their cut in fees regardless of performance. You can count on that.

Let’s add up the pain. Imagine that a $10,000 investment to which you add $10,000 a year for three decades grows at 1.9% — just the dividend yield gets reinvested, so we’re not counting appreciation for the moment. At the end of 30 years, then, you should have $424,564.

If instead you reinvest 0.7% (which is what really happens to many folks), your return over those years comes to $347,192. You get $77,372 less of the money you earned over the years. All of that cash goes to the managers.

Square one

You might be itching at this point to interject, “Well, I’m not worried. My manager beats the market.” And you might be right about that this year and next. But over the long run he won’t.

Fund managers eventually have down years. They give back the earnings of previous years. They gather up too much money and start to post returns that match the market before fees. Subtract those fees and quickly you fall behind.

Or they just retire. Nobody stays on top for the 30 years of a typical long-term retirement plan cycle. Even the supposed superstars tend to go in and out of favor every few years as different markets demand different strategies, assuming you can access the big-name managers of the moment.

As those outlier strategies begin to win, of course, copycats rise up and destroy any differentiation. We’re back to square one, and the only part of the equation that remains unchanged is the flow of fee payments.

That money flows just one way, by design — out of your plan and into the pocket of a broker.

Send this to a friend