Better returns can’t be explained any more simply: If you worry about the pennies, the dollars take care of themselves.
Often used to explain budgeting, the old adage applies very well to investing, too. That is, if you can keep your cost of retirement investing to a minimum, you will have more money in the end.
What cost? Well, if you trade often, there are commissions to pay. If you invest outside of retirement accounts, there are taxes to consider. Trading emotionally — chasing expensive stocks higher or bailing out of “losers” at the bottom — will cost you big.
But I’m talking about something even simpler. It’s not one large mistake but a simple, small one, made early on and never corrected: too-high investment fees. Like water dripping, these apparently tiny fees turn into buckets and, finally, a flood of lost money.
Let me explain. When you hire someone to do your retirement investing for you, whether it’s a financial adviser, a mutual fund company or both, they naturally expect to be paid.
Those payments show up in your account as periodic investment management fees. Often charged quarterly, the fees are based on the size of your portfolio.
It sounds fair. If you do well, they do well. And it is fair, insofar as it goes. A good adviser should be rewarded for performance over time.
Here’s the trouble: Many investment advisers assure themselves of being rewarded handsomely for doing absolutely nothing at all or, worse, for earning you less than you might have earned by by owning the market itself.
They take out a small-seeming slice — 1% for the investment adviser, another 1% or more for each individual mutual fund company — and squirrel that cash away. You don’t know how they choose to invest that money, now their money, but be assured that they do.
What happens next, with any luck, is compounding. Every dollar you own should be doubling in a just a few years as gains are reinvested.
As time passes, of course, every penny they took from your account is working on behalf of the managers, not you. They don’t build up your account and then take out a slice. They deduct it continuously and invest that cash separately, on their own.
Better returns the simple way
The impact is enormous. Over the course of 10 years, a fee of 1.27% can extract almost a third of your retirement investment return—close to 30%. That’s the pennies turning into dollars, the drip-drip-drip of money adding up to buckets of cash over time.
Ordinary people don’t understand how this works. Money pros would vastly prefer that you remain blissfully ignorant. Essentially, that’s their business model.
What can you do to turn this around? First of all, choose index funds over actively managed funds. Index funds and exchange-traded funds (ETFs) are vastly cheaper to buy and to own.
Second, keep your investment adviser’s fees in line with the value you receive. Investment managers sometimes provide service that brings value to your long-term retirement investment performance, as well as powerful support in emotionally trying markets.
Keep those costs minimized and you will reap the rewards you deserve in retirement.