When people invest, they often watch the bigger numbers like returns and dismiss smaller numbers like fees.
The markets have been getting pummeled after they topped out in January of this year. I often tell family and friends to closely watch the fees, but during up markets, most fail to keep fees in focus. The truth of investing is that the real money is often made at the margins and fees hit us at the margins. A small percentage fee represents a big amount over time.
Compounding of returns is one of the best parts of long term investment. Essentially, this means returns on returns. As returns are made and reinvested, the “snowball”, as I call it, grows bigger and bigger at an exponential rate. This is the primary reason that I have a rule of never, never ever removing earnings from the investment portfolio. Each time an investor removes earnings from their portfolio, they voluntarily cut their investment returns. Sure, there comes a time when the portfolio is supposed to provide income for living, but before that time, depending on your age, letting compounding and time work to your advantage is essential.
While compounding returns can help your returns, compounding of fees drags your portfolio returns down. For example, a 1.5% fee doesn’t sound like much to many investors but over a ten year time period represents a 16% DRAG on your returns ( 1.015^10)! Even worse is when the market goes down, because the investor’s returns for a time period become negative. Why, even worse? The wrap fees are still taken out of the portfolio – while the investor is getting negative returns! In essence the management company and broker still makes money while the investor loses money in down markets. Now that doesn’t seem equitable.
Often investors accept a “wrap” fee of 1.5% by their broker to manage their portfolios. When you consider that often those investors have mutual funds which have their own annual expenses, there are even more fees being carved out from their returns. Those are fees on fees. ETF’s are subject to fees within those ETF’s too.
So watch your fees if you want to benefit yourself versus your broker. But if you want your broker to get brand new high end cars, planes and homes, by all means, ignore those fees while your drive your older, beat up car by your broker’s luxurious home!
Be smart, be well-read, be aware and be successful.
