That’s how investment fees work. Bit by bit they pick away at the fruits of your investments, gradually weakening the roots and stunting your portfolio so it never grows to its fullest potential.
While forking over a few dollars for commissions or sacrificing several fractions of a percentage to cover management fees may not seem like highway robbery, keep this in mind: The same compounding math magic that shows how small amounts of money grow and become big sums over time works in the other direction, too. When you apply it to investing fees instead of investing gains, the results are devastating.
There’s No Such Thing as a “Small” Ongoing Fee
Fees are one of the biggest -- if not the single largest-- destroyer of investor wealth. And when left unchecked over time, investors unwittingly sacrifice large sums of money and a good portion of their future quality-of-life.
Consider the difference between paying 0.5% in fees vs. 1.5% in fees on a one-time $25,000 investment that earns an average annual investment returns of 7% for the next 35 years.
- If your investment fees come to just 0.5% each year, your balance will grow to $227,000 by retirement.
- Using the exact same scenario but shelling out 1.5% in fees and expenses, you end up with just $163,000. That additional 1% you pay in fees and expenses during those 35 years slashes your returns by a whopping 28%. That’s $64,000 that could have been padding your pocket, not some management firm’s.
Most investors understand that advisors, brokers, and money managers take a cut of your profits in exchange for managing clients’ money. But Wall Street’s pickpockets also lurk of some in some less obvious neighborhoods -- including at your place of employment.
Your 401(k) Is a Prime Target
If you aren’t aware how much you’re paying in fees within your employer-sponsored retirement plan -- or even that you pay any fees at all when you participate in the plan -- you’re not alone.
In an AARP study about 401(k) fee awareness, more than 70% of respondents said they knew of no fees associated with investing in their workplace retirement plan. When told that there are indeed costs, three out of five respondents said they had no idea how much they might be paying. When asked to take a stab at it, many participants guessed that they were paying anywhere from 0% to 5% in fees. [AARP: http://bit.ly/1GExMOm]
They weren’t far off. Most 401(k) plans charge between 0.05% to 2% (sometimes more) of assets under management. [AmericanProgress.org: http://ampr.gs/1PpWRnt]. You just saw in the example above how much a 1% increase in investment fees affects a single, one-time $25,000 investment over time. Now imagine the blow to your portfolio if you’re continually adding money to your retirement kitty and 1% that’s skimmed right off the top of your growing balance year after year after year.
Here’s how a 1% fee affects the diligent saver over time:
- If you start working at age 25 earning a median salary of around $30,000, get nominal raises each year, and finally retire at age 67: During the 42 years you’ve contributed to your workplace retirement plan, you will pay nearly $140,000 in 401(k) fees. That $140,000 is roughly equal to two and a half years worth of earnings for a typical U.S. household.
- Now, if you start off at age 25 at a salary of $75,000 a year (and also get those nominal raises), your 67-year-old self is not going to be a happy camper when they figure out that they’ve paid more than $340,000 in 401(k) fees over their lifetime. That’s $340,000 that should have remained invested and working for your future and not peeled off dollar-by-dollar to pad someone else’s coffers.
The First Step to Slashing Fees
There is no better way to improve the performance of your investments than to cut your fees. At FutureAdvisor we believe so strongly in making sure investors know exactly what they’re paying for -- or over-paying for -- that we offer a free portfolio analysis to everyone.
Don’t spend one more dollar on unnecessary fees. Get a free detailed screen of your current investments (including the ones in your 401(k)), and, if we spot any fee funny business, we’ll give you free recommendations for low-cost, tax-efficient, diversified mutual funds and ETFs.