Making money in the stock market is no easy task. In a rising market, it may seem simple because you can throw money at almost any stock and find it higher in price 12 month later. But when you factor in the swings lower during economic recessions, few people have the skills to beat the market during a full stock market cycle. It’s for that reason Jack Bogle, founder of the Vanguard Group, advocated for diversified portfolios that track market performance long before so doing was popular.
These days most investors are savvy enough to know that investing in a diversified portfolio over the long term is the best approach. But what most investors don’t realize is that a hidden investing danger lurks, and it can eat away at portfolio returns slowly each and every day, eroding a significant chunk of any nest-egg over the long-term.
Imagine an investor who visits a financial advisor to request advice on how to allocate money for retirement. The financial advisor displays some charts that rise from the bottom left of the page to the top right, and projects future returns, which of course seem enticing. The investor’s appetite is whetted at the prospect of making money over time. But what the financial advisor fails to reveal is something very costly.
You see, the dirty little secret of the financial advisory business is the sum of all costs borne by the client. These costs aren’t just management fees but also include lots of other “hidden” costs. Management fees are disclosed in quarterly statements and they are keenly analyzed by clients but another charge incurred by clients is not scrutinized as much by them, and that is the expense ratio cost.
Each time your financial advisor invests your money into a mutual fund, an ongoing expense is charged that you don’t see because it occurs at the fund level. When you add up the cost of your financial advisor’s management fees in addition to the cost of expense ratios, the total annual cost can be as much as 2% of your assets each year.
That may not seem like much until you work through the math, which we did! If a $100,000 portfolio grew at an average rate of 8% per year, the value would amount to a whopping $1,000,000 after 30 years.
Now compare that same $100,000 which is subjected to 2% fees each and every year for the same 30 years, and also grows at 8% annually. Well, it turns out that portfolio would grow to approximately $550,000. That’s a whopping $450,000 in savings!
Of course it’s a little unrealistic to expect to pay no fees whatsoever when investing but let’s conservatively say you paid 0.50% annually overall, which is actually about twice as much as some top robo-advisors, such as Betterment charge.
In this scenario, the portfolio would grow to approximately $866,000 in value, which is still over $300,000 more in your pocket than in the pockets of your financial advisor and the mutual fund managers.
The bottom line is you can save not just a few dollars but perhaps hundreds of thousands of dollars over the course of your investing lifetime by carefully analyzing and minimizing how much you pay in management fees, expense ratios, and also trading commissions. When you crunch the numbers, you too might find that it is best to consider investing with a top robo-advisor versus a traditional financial advisor!
And if you are not yet convinced, break out a spreadsheet and work through the numbers. Surprising as it may seem, the reality is a small percentage cost each year can add up to a huge chunk of change over time. It can be deceiving because most investors think about the spread between historical average returns and compare them to costs. So, most people think “ahh, if I make 8% and pay 2% in fees, that’s still a good return” but 2% of the starting principal of $100,000 is still a lot of money to pay in fees each year.
Because the percentage amount is small, clients typically don’t pay as much attention to it as they would if their financial advisor said “the charge this year will be $2,000.” Worse still is the client with say $500,000 who pays $10,000 per year in total costs – assuming the same 2% figure.
If you knew you were committing to paying $10,000 per year for a service, how carefully would you evaluate it? Most people work awfully hard to build up a savings nest-egg but unknowingly sign away a big portion of it to fees after a cursory meeting with a financial advisor. Don’t be one of those clients who focuses on small percentage figures. Instead, keep your eye on the total amount of dollars paid in fees each year, and you will find yourself ahead of the curve.
Related Posts
Also on Market Tamer…
Follow Us on Facebook