There are few certainties in life, and probably even fewer when it comes to investing. One guarantee that I can make is this: what you don’t spend, you get to keep. Fees matter. Especially when it comes to your money. Those fees come in many designs, from professional advisor fees, to trading fees, to product fees, both visible and “hidden.” Product manufacturers (insurance and mutual fund companies) would argue that all fees are disclosed, and they would technically be correct. However, when you bury them inside a product prospectus that is hundreds of pages long in some cases and expect the common consumer to be able to first spend days reading it, and then fully understand it, I would argue they are “hidden” by my definition.
Let’s look at some numbers – they are meaningful to say the least. Assume you have a $1,000,000 portfolio of mutual funds. According to Vanguard, the industry average expense ratio of a mutual fund is 0.62%. That’s about two-thirds of one percent. That figure has come down in the last decade due to the pressures applied to the active management of mutual funds by the lower-cost passive strategies. A passive investment strategy invests in a broad-based index rather than playing the difficult game of trying to actively pick winners and losers. Rather than invest in your average cost mutual fund, you could opt to invest in a lower-cost fund such as those at Vanguard, whose average expense ratio of a mutual fund is 0.12%! Some of you might be inclined to say, “well that’s only a half percent lower.” True in year one, but then comes that sticky little concept of compound interest. On our hypothetical $1,000,000 portfolio, the impact of that savings over 10 years is $86,000, over 20 years it is $299,000 and over 30 years (say, retirement?), it is $774,000. Yes, you read that correctly. Would three-quarters of a million dollars come in handy during your retirement?!? This chart (Source: Vanguard) highlights the impact.
Other product fees, such as those found in variable annuities can be HUGE! Those commissions aren’t charity to the person who sold the annuity. An insurance company has many embedded fees that can add up to several percentage points. All of that is creating a drag against the performance of your money.
Trading costs can be another silent killer, but their impact has been muted in recent years as the major custodians (Charles Schwab, Fidelity, TD Ameritrade, E-Trade) are in an arms race for your business and continue to lower their trading fees. I honestly expect to see an advertisement in the next 10 years touting penny trades. Unless you have an unscrupulous broker day-trading your account (or you’re foolish enough to do that yourself), trading fees are having less of an impact today.
Finally, the last type of fee I will address today is that of the advisor. Advisory fees come in all shapes and sizes. It would be hard to cover them all here so I will say this: make sure you are finding value in exchange for what you are paying, and do not overpay. First, look for a fee-only advisor as they are less likely to have a conflict of interest with you. Second, just because you have a lot of money does not necessarily mean you have a more complex situation to work with. Too often, advisors charge a client with $2 million dollars twice as much as they charge someone with $1 million dollars. And they are doing basically the same work! Let’s hypothetically say the $1M client is paying $10,000 annually for their financial planning and investment management services from their advisor and the $2M client is paying $18,000 annually. For the extra million dollars of assets that need managed in the second example, let’s assume an additional $2,000 annually would cover the extra work, if there is any. In this example, the fee should be $12,000 per year instead of $18,000. Further assuming the client is 55 years old, will live to age 90 and will receive a 5% rate of return on their investments, that $6,000 savings will amount to a little more than $540,000! Couple that with our earlier savings of $774,000 and that’s over $1.3 million dollars! Who do you want to get that money? Your advisor and the product companies, or your children and grandchildren? Fees matter.