There is a lot of talk about investment fees today. But why do they matter and why should you care so much? Who cares if you pay an extra $100 of fees today, right? Wrong!
What may seem like tiny sums can add up to huge piles of money over your lifetime. It may mean a few extra vacations when you are older or an extra year of spending. Ever hear that old Benjamin Franklin adage –”Small leaks sink big ships.” Nowhere is it more true than with investment fees in your financial accounts.
And the reason is that these seemingly small amounts matter is that they compound over time, lowering the rate of return you earn each year. The impact of investment fees is felt through lower returns earned year after year. That means after a decade or two, you have significantly less money than you should! In English, that means your money grows slower. And who wants that?
An example will help you to understand the magnitude better. You have $50,000 to invest. You have two options, both of which will earn you 7.0% before any investment fees.
Option 1: you invest in an investment fund with a 5% upfront fee (often called a “load fee”) and annual expenses of 1.25% (called an “expense ratio”).
Option 2: you can own an index fund or a basket of ETFs that cost you on average 0.75% each year.
After 10 years of this, your Option 1 balance is $83,080. Option 2 balance is $91,676. That’s a difference of $8,600. After 20 years, its $23,000 and after 30 years it is $54,000. Makes you think twice about why that extra $250 in year one even matters.
While this discussion is a very high level overview, there are all types of “costs” — some hidden, some visible — that you should be aware of. Transaction costs, expense ratios, load fees – and yes — taxes! A prudent investor looks to minimize all of these “controllables.”
As part of my practice, I like to give clients complete fee transparency. I look across all their products and accounts and come up with an estimate for what they are paying in fees. You would be surprised at how most people have no idea and just how much they are paying. How would you react to finding out that you are paying an extra $5,000 when you don’t have to?
The main reason I believe why people are so surprised is because they are not writing a check for this amount. It is usually buried deep in your investment performance or most people don’t bother to look.
Now, some reasonable level of investment fees is to be expected, but it is about keeping them in check and under control so as to keep the math working in your favor!