After 20 years of being an advisor, I’m still shocked at how many people still don’t pay attention to the fees associated with the management of their investments. When I ask how much their current advisor charges, if they don’t stare blankly back at me, they usually say something like “Well, I should really know that, but I don’t have a clue”. Worse, some people not only don’t know, but don’t care. But should they? If they care about securing a stronger financial future for themselves and their loved ones, then the answer is a resounding yes.
Many industry experts argue that cost is the strongest determining factor affecting an investor’s long-term investment returns – even more important than asset allocation, market timing and security selection. Famous investors such as Benjamin Graham, Warren Buffett, Jack Meyer and John Bogle all agree on this point.
There’s nothing to argue about, really. It’s a fact that the costs incurred while investing reduce investment returns – it’s simple subtraction. When it comes to professional investors (investment advisors like me, or mutual fund managers), the greatest hindrance to our long-term performance is the fee we charge. The more an advisor charges for its services, the more difficult it is for them to earn that back for their client and ultimately justify the fee. Consequently, on average, the best investment return performances are earned by those managers who are able and willing to charge less and they use investment vehicles that have no or low “costs to hold”. Which is the exact opposite of that old adage “you get what you pay for” that so many marketing slogans are based on.
Look at the stellar performance and success of The Vanguard Group. It’s founder, John “Jack” Bogle (who created the world’s first index mutual fund in 1975) has said: "The grim irony of investing is that we investors as a group not only don't get what we pay for, we get precisely what we don't pay for. So, if we pay for nothing, we get everything."
To illustrate the significance of even a ½% annual difference over a long period of time, let’s take 2 different investors, Jim and Susan. They are both aged 60 and each is retiring with a $2,000,000 nest egg. They need to withdraw $80,000 in the first year and increase this amount by 3% in each subsequent year to account for inflation. They both invest in the same investments at the same time. They are both able to achieve a “gross” average annual return over the next 30 years of 6%, however Jim incurs total costs of 1% per year, and Susan incurs only 0.50% per year. At the end of 30 years, Jim is left with $315,935 to pass on to his heirs, whereas Susan has $1,004,392 to pass on to hers– an increase of 218%!
But don’t forget, it’s not just the advisor’s management fee you should pay attention to, but the costs associated with trading and holding the investments in your portfolio. There are other “costs” that investors face, such as taxes on investments as well as investor behavior (i.e. making dumb mistakes), but that is outside the scope of this article.
Here are three rules to follow to be a more successful investor: 1) Get and stay diversified over a lot of different asset classes; 2) Keep your “all-in” fees as low as possible. This will be easier to do if you are a “do it yourself investor”. But, if you need help and want to hire a professional advisor, you owe it to yourself to make sure that advisor adheres to this philosophy and their fee structure reflects that; and 3) Invest for the long-term. If you need the money back in just a couple of years or less, keep it in cash.