Compound interest is an idea at the heart of investing. While the bankers in Mary Poppins probably explained it best, we're going try to define it ourselves.
The operative metaphor is drag, the friction your body produces as you move through water. Wet clothes produce tons of drag, weighing down your arms as they stroke and your legs as they kick.
The financial equivalent is investment fees on your money, and in particular, the expense ratio of investment funds. High fees produce drag on your investment, and low fees mean you're traveling as fast as the stock market can carry you.
Investment fees should be like a bikini: large enough to cover the bare necessities, and small enough to be interesting.
One of the main fees you'll encounter when you invest in mutual funds, target-date funds or exchange-traded funds is the expense ratio. An expense ratio is the percentage of your money that you pay the fund just to be able to invest. It's the ticket you buy at the entrance to the stock market.
The best thing a financial advisor can do for you is minimize your investment fees, since they slow you down year after year. Online services such as FutureAdvisor show you how to cut your fees for free.
Let's talk about what large and small mean when you talk about investment fees. An expense ratio of 100% would take all your money and leave you nothing to invest. Bernard Madoff's investors were paying an expense ratio of 100%, they just didn't know it.
The lowest-fee index funds, which purchase a slice of the entire stock market and spread your risk, cost only 0.04%, or 4 basis points. Note that index funds outperform 80 percent of all investment professionals in any given year, so cutting your fees doesn't mean conceding performance.
Meanwhile, the most expensive mutual funds charge anywhere from 212 basis points to 328 basis points. I'm looking at you, ALPS/Red Rocks Listed Private Equity Fund (Class A). That's almost 100 times the lowest-fee index fund. You might as well put on your winter coat and try to swim across the river.
There's no better way to improve the performance of your investments than to cut your fees. And there's no easier way to find low-fee funds than with a free analysis.