Investment Fees are Evil: Maximizing Return and Minimizing Risk by Using ONE Metric

Investment Fees are Evil

September 17, 2018

The dynamic I'm about to describe is found in every industry: one product or service being astronomically more expensive than another with very little differentiation between the function of the options.

It is easy to see in cars, you can buy a brand new Honda Civic or similar for 20-25k cash. OR you can go out and purchase a Lamborghini/Similar Supercar for 200-250k. What’s the difference? One may be faster, subjectively nicer looking, and made of better quality materials. So you can POTENTIALLY justify paying 10x the cost, even though they are both just forms of personal transportation.

In investments, there is no real “sticker price”. When you purchase $10,000 worth of a mutual fund, that money is still all yours. (Unless the mutual fund has something called a “load fee”, which takes away a % of your money up front, we stay away from those here) The real “price” of a mutual fund or exchange traded fund investment is baked into something called the “management fee” or “expense ratio”.

Similar to buying a car, the “price” or “expense ratio” can vary wildly. Expenses range from less than .05% to over 1% of your money PER YEAR. These fees are paid directly to the managing company of the fund you are invested in. (Vanguard, Fidelity, Blackrock, Etc...)

Personally, I invest in shares of a Total Stock Market Fund from Vanguard with an expense ratio of about .04%. (Or $4/yr for every $10,000 I have invested) This passive exchange traded fund tracks the performance of all US Stocks, so it is basically a long term investment in the US economy. A similar fund that does the same exact thing from a competing money management company may charge .5%. (Or $50/Yr for every $10,000)

Do you see the underlying issue? Both funds are offering me the exact same UPSIDE (because they are invested in the same thing, the total US stock market) but one has 10x the fees! Over one year, the fee difference seems minimal. But over 30, 40, or 50 years, a .45% drag on performance adds up big time. You're taking on the same amount of risk for less profit.

Using a simple compound interest calculator, like this one HERE, you can see that if you start with $1000 today, and compound that at 10% per year versus 9.54% (10%-.46% difference in fees) for 50 years, the ending balance will be about 23% less! ($117k for the 10% growth and only $95k for the 9.55%)

If you make monthly additions of $100 to the beginning balance of $1000, (which you should do!) the difference is actually staggering. You would have thrown away over $200k in fees. (A difference between having $1.6 Million at 10% growth and $1.39 Million at 9.55% growth in 50 years.) There goes your Lamborghini!

With these investment choices, you could be paying LAMBORGHINI PRICES for the same exact HONDA! Would you ever do that when purchasing a car? Obviously not, but it is not as clear when it seems like “only .45%/year” on paper. Humans are inherently bad at estimating long term mathematical calculations. Acknowledging this, we should take extra care when analyzing our ultimate long-term mathematical decisions (our retirement investments!).

If you are interested in learning more about how to invest and build wealth for the long-term, check out my articles "The Glacier Approach to Investing" and "Financial Independence: The 3 Step Process".

A great book that covers this topic and other fascinating topics relating to this is MONEY Master the Game by Tony Robbins. Tony really dives deep into the basics of investing and personal finance, so it is a great book for the beginner or intermediate level investor!

MDAS

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P.S. New blog posts coming your way every Monday!

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