“Beware of little expenses. A small leak will sink a great ship.” – Benjamin Franklin
Most retirees concern themselves with large market fluctuations, major economic calamity, or fraud. With good reason, the large, sudden, dramatic loss always seems to be the greatest concern for investors. However, often-overlooked are the consistent, grinding expenses and fees that can gradually eat away at your returns and pin your portfolio down, preventing it from achieving its maximum potential.
Ann & Betty
Ann and Betty were both 65 and met each other at a widows’ support group. They both wanted to retire and had no intention of remarrying. Despite the $1,000,000 they each had sitting in a savings account, neither had a clue about money and certainly did not know how to generate the income they needed to live. Ann went to a financial seminar and listened to a slick salesman sell her on a financial product he had that would guarantee her $74,549 for 25 years. She was so excited, she told Betty with the intention of convincing her to invest as well.
Betty was skeptical. She shopped around and found the same investment vehicle with 1.5% less in commissions and fees. Betty’s annual income for the next 25 years was $85,810. She received more than $11,000 per year more than her friend because she was careful to avoid high fees.
We live in a world where cost has a direct relationship to quality. BMWs can be expected to perform better than Chevrolets, Hagen Daz tastes better than Turkey Hill, and The Cheesecake Factory is better than McDonald’s. “You get what you pay for” is a mantra we hear time and again. Although this may be the case on Main Street, the truth on Wall Street is very different.
Studies have shown that the only correlation between fees and returns is an inverse one. Higher fees consistently lead to lower returns. Low fees should not be confused with no fees. Attempting to handle your own finances usually ends up costing far more than the fee. It is never advisable to avoid one problem by creating another.
It is possible to find a fee-only CFP® who is as concerned about your investment fees as you are. If your financial planner is worth his salt, he will understand the relationship of fees to performance and do everything in his power to keep them as low as possible without sacrificing return.
The use of index funds is the surest way to keep your fees to a minimum and not fret about possible market underperformance. An index fund is a group of stocks that are pre-assigned; they are not actively managed by a fund manager. The index fund tracks an underlying index, like the Dow Jones Industrial Average, and rarely makes changes to the makeup of the fund. A common example is an S&P 500 fund that tracks (you guessed it) the S&P 500 index. The index is run by a committee and makes changes infrequently, thus, it is not subject to the emotion or whims of an individual whose career is on the line. This can be very beneficial to the investor.
Index funds traditionally have far lower expenses than actively managed mutual funds because they have far less overhead to operate the fund. Index funds usually do not have loads. This is why index funds are so often shunned by full commissioned brokers; there is no commission to be had, thus no income for them. However, fee-only investment advisors are often very receptive to index funds as a large percentage of a portfolio.
Investment fees are unavoidable. In order to have the proper level of diversification, they must be accepted as part of the process. However, all investments are not created equal. Two funds could be exactly the same and have two very different sets of fees. Keeping your fees to a minimum will ensure that you are able to expel every last ounce of juice from your money tree once it begins to bear fruit.