Should You Be Watching Fees?

My answer would be unquestionably and without reservation a resounding yes. While you can never get rid of all fees, as a smart investor, you should minimize fees at every turn. 

One of the primary elements to successful investing is to minimize fees. This is something EVERY INVESTOR should ALWAYS keep their eye on. Fees can eat up your returns as a result of time and the compounding effect.

The investment industry absolutely loves fees. And, while some fees are a necessary component to incentivize the financial community to do their work, fees have gotten very high. In the 1950’s, the fees for managing a portfolio were about 1/10 of a percent. How things have changed!

The longer period you invest for, the effect of the fees grows at an increasing exponential rate. This is especially important if you are saving for retirement because your goal could be 15, 20, 25 or more years out.

Also, the higher the rate of return on the investment, the greater the compounding effect.

It is interesting to note how many people will look at the absolute interest they PAY on their mortgage over the life of the mortgage, but fail to perform the same analysis on the return they LOSE on their investments over their investment horizon as a result of fees.

The formula to Know

TAKE TIME TO UNDERSTAND this formula as it can be the difference between having a great retirement and a marginal one!

One of the most fascinating features of mathematical growth rates is the beauty of compounding. It is captured in this simple yet powerful formula. This formula can be easily used by you by simply plugging the numbers into the variables. 

A = P ( 1 + r)^t

The meaning of the variables are as follows:

A = Value of the investment at the end (value of investment at maturity).

P = Current value of the investment (amount invested initially).

r = Rate of return per year (interest or return rate) on the investment

t = Number of years the investment is invested.

^ = power of sign

Example to Understand - 25 years

Now, let’s say you invested $10,000 for 25 years at 6%.  The value at the end is $42,918.71.

42,918.71 = 10,000 ( 1 +.06)^25

If you paid fees of 2%, you could have earned 8% without fees (6% + 2%). The value at the end is $68,484.75. This is a difference of $25,566.04 (68,484.75-42,918.71)!

68,484.75 = 10,000 ( 1 +.06)^25

So what did the 2% fee do to your returns? You started with 10,000, so at 8% you would have earned 58,484.75 (68,484.75 minus 10,000 original investment). Your initial investment would have multiplied 5.8 times (58,484.75/10,000).

With the 2% fee, you would have earned 32,918.71 (42,918.71-10,000). It would have multiplied 3.3 times (32,918.71 / 10,000).

I don’t know about you, but I’ll take my investment being multiplied 5.8 times anytime over it being multiplied 3.3 times.

Example to Understand - 35 years

Now, if you increase to the time period to 35 years, here are the results.

With a 2% fee, the value at the end is $76,860.86 or it multiplied 6.6 times ((76,860-10,000)/10,000).  

76,860.86 = 10,000 ( 1 +.06)^35       

Without the 2% fee, the value at the end is $ 147,853.44 or it is multiplied 13.7 times ((147,853-10000)/10000) 

147,853.44 = 10,000 ( 1 +.08)^35  

The dollar difference is 70,992.58. The original investment was multiplied 13.7 times without the fee and 6.6 times with the fee – a huge difference!

Example to Understand - 25 years with a “Load” fee

Here is another really important point. If you are paying a “load” to buy a mutual fund, you are losing even more. With a load of 4.5%, you are paying a fee IMMEDIATELY upon purchasing the fund! This means that for every $100 you put in a fund, only $95.50 goes to work for you.

In our example above for 6% and 25 years, the formula changes as follows:

40,987.36 = (1 - .045)(10,000 ( 1 +.06)^25) 

Because you paid the “load” of 4.5%, you lost almost another $1931.35 (40,987.36). The $450 sales charge cost you 1,481.35 or 3.3 times (1,481.35/450). It is even higher because the 450 was a fee, unlike your 10,000 initial investment that you get back. This is the result of two factors. By paying the sales charge, you had less money initially working for you and the money NOT working for you didn’t compound.

Summary

Now you can put your own numbers in this formula to see the effect it has on your own investments. An 8% average return on the market is at the low end for long investment periods of a 60/40 stock/bond portfolio.

But, always remember, FEES MAKE A HUGE DIFFERENCE. The higher the rate, the higher the initial investment and the longer the period, the greater effect it has upon YOUR returns.

While you can never get rid of all fees, as a smart investor, you should minimize all fees at every turn. 

After all, are you providing for your retirement or the investment industry's retirement?

As they say on TV, "You make the call!"