You’ve probably seen or heard advice (maybe even from me) about how to cut investment fees by using low-cost investments like index funds. But the fees always seem small, often just 1 or 2 percent, and you may never even see them deducted.
So why should you care about these “small” investment fees and expenses?
Because every dollar you don’t pay out in investment fees and expenses not only remains in your account but compounds over time, growing your savings even more. And because the investment allocations are the same either way, you can take the same amount of risk and earn a higher return with lower fees.
It’s common to find that once you factor in all your management and other investment fees and expenses, that you can cut your costs by as much as 1% or more without sacrificing the quality of your investments or service providers. You’ll be astounded by the extra money you’ll save over time with low-cost investing.
Fee Impact on a Lump Sum Investment – An Example
Consider two $100,000 portfolios; one with low costs and one with high costs. After 30 years, a low-cost portfolio earning a 7% investment return with total expenses of 1% finishes with an ending value 58% higher than a high-cost portfolio with total expenses of 2.5% earning the same 7% gross return.
- The $100,000 high-cost portfolio would grow to $356,000 in 30 years, after fees.
- The $100,000 low-cost portfolio would grow to $563,000, a $207,000 difference!
And that’s without any increase in portfolio risk.
Depending on how much money you’re investing and for how long, a .5% to 1% fee increase could result in tens or hundreds of thousands of dollars in lost savings.
Fee Impact on a Lifetime Investment Plan – An Example
Here’s an example of how fees impact a lifetime savings plan. An investor depositing $1,000 a month for 30 years, earning a gross (before fees and taxes) annualized return of 7%, would have the following ending balances:
- With fees of 1.0% annually: $979,256
- With fees of 1.5% annually: $894,909
- With fees of 2.0% annually: $818,698
- With fees of 2.5% annually: $749,809
As you can see, a 1.5% fee decrease (from 2.5% to 1%) increased total savings by $229,000! That’s more than a 30% increase in the total amount saved!
Even just a .5% fee savings (from 1.5% to 1%) increased total savings by $84,000! That’s more than a 9% increase in lifetime savings!
It’s hard to focus on small details about small numbers like fee disclosures, but here’s the thing to remember; seemingly small fee differences can have a major impact on your financial future. Make sure you understand exactly what your portfolio is costing you, and don’t be afraid to ask your advisor to put it all clearly in writing. With investment fees and expenses, it pays big to sweat the small stuff!
– Daniel M. Flannery, CFA