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I was born in 1979. If my parents had invested $1,000 in a no-fee S&P 500 index fund, and had re-invested all dividends, the stake would have grown to be worth $80,601 on my 40th birthday.
That’s a gain of 81 for 1.
Meanwhile, a $1 million investment by the endowment at a college would have grown to over $80 million.
But here’s the math that’s hardest to believe: if the college had paid a seemingly small 2% investment fee then its gain would have been cut by half, to just $39 million.
That’s what happens over 40 years when the 11.6% annual return achieved by the S&P 500 is recalculated at a 9.6% rate.
Warren Buffett once estimated that endowments and pension funds and wealthy people wasted $100 billion on fees over a 10-year period, but how much do fees matter for someone investing $100,000?
Firstly, they could buy low-cost index funds, building a simple portfolio of stock and bond funds charging close to a zero percent fee, say 0.02% blended. If the investments earn 8% over the next 40 years the $100,000 will have grown to be worth $2,156,000.
Secondly, they could invest the entire $100,000 into a single lifecycle or target date fund charging a 0.75% fee. If the investment earns the same 8% over the next 40 years it will have grown to be worth $1,644,000.
Think about that.
You lose over half a million dollars just from this small difference in fee, because small amounts multiplied over 40 years always become big amounts at the end. Everyone loves talking about how compounding interest is key to building wealth, but it cuts both ways. Fees compound too.
Lastly, they could hire “professional help” just like an endowment or wealthy person might.
The typical adviser charges a management fee, and having $100,000 under management will cost roughly 1.25%. Combined with the underlying investment fees the “all-in cost” is closer to 1.85%.
If the adviser returns 8% over the next 40 years the $100,000 investment will have grown to be worth $1,088,000.
This time the small difference in fee causes up to a $1 million shortfall. Here’s another way to look at that. If you learn to manage your own money rather than pay a 2% fee you may need to save only half as much money for retirement.
(Incidentally, “fees” are how cities like Las Vegas get built. Transferring small amounts of money from customer’s pockets to casino’s coffers.)
But like most things in life, there’s no “right” way to invest.
Naturally, some people don’t have the time nor interest to invest on their own. They’ll happily pay someone else to do it for them. There’s no problem with that.
The problem is when people think their money is buying them something better. Actually, it’s quite common. You always expect more when you spend more, whether on a hotel, piece of jewelry, restaurant, or whatever.
But with investing the opposite is often true. The more you spend the less you get. The harder it becomes to reach the level of wealth you aspire to.