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How Investment Fees Affect Your Returns – They Might Cost You $500,000

Every investment has a cost associated with it. Unfortunately, these costs aren’t all created equal and the investment fees you might end up paying could cripple your returns.

If you’re just starting your investment timeline or to better plan out saving for retirement, understanding the potential fees associated is paramount. Just read any personal finance/financial independence book or blog, you’ll see the anguish and hatred these authors have for investment fees. I’ve included a bevy of links to resources at the end of this post.

Not only are these higher fees costing you the amount you’re paying for the management and operating expenses, the compounding loss of the opportunity cost of those dollars not being invested in the market is cataclysmic.

Investment fees might take hundreds of thousands of your hard earned money out of your pocket and into someone else’s over your investing timeline.

If you’re earning and saving at a higher rate throughout your entire investment time-frame, they could cost you north of 7-figures.

To help highlight the effect these fees have, let’s run a case study comparing 3 different investing scenarios.

INVESTMENT FEES CASE STUDY CONDITIONS

We aren’t looking into risk profiles, asset allocation, different accounts, re-balancing, other investments within a portfolio or any other financial levers like taxes, capital gains, inflation and so forth.

Strictly the role investment fees play on your returns.

To help make this a controlled environment we have to establish some consistent parameters for our investment scenarios.

Timeline: 30 years
Starting Investment Balance: $10,000
Monthly Contribution: $1,250
Average Market Returns Over Timeline: 7%
Investment Calculator Used: Smart Asset

Each of our scenarios will have exact matches in terms of starting investment balance ($10,000) and their monthly contributions ($1,250).

The independent variable (what we’re changing) between the scenarios will be:

The investment fund and means of managing that fund

The dependent variable (what’s being impacted) will of course be

The net investment value at the completion of our 30 year timeline.

With that in mind let’s explore what these potential fees can do to our investments and how they can affect our returns.

SCENARIO 1 – THE SAVVY COUPLE: DIY INDEX FUND INVESTORS

Our first scenario comes from Dave & Cindy. This 28-year old newlywed couple lives a middle-class lifestyle and were lucky enough to stumble upon JL Collins Simple Path To Wealth.

They knew right after their wedding expenses had been sorted out they were ready to become long-term, low-cost DIY index fund investors with Vanguard.

They have a lump sum of $10,000 to start their account and will continue to contribute $1,250 monthly across a 30-year timeline. The savvy couple knows investment fees are a crippler and will just be purchasing VTSAX through their own Vanguard account.

Starting Investment: $10,000
Monthly Contribution: $1,250
Vanguard Total Stock Market Index Fund (VTSAX)
MER: 0.04%
True Return Over Timeline (after fees): 7% – 0.04% = 6.96%

Dave & Cindy will have $1,593,185 in their account at the culmination of those 30 years.

A hefty sum of money to live a comfortable life in retirement. They’ve likely paid off their mortgage much earlier in life and were also contributing to other retirement accounts or pension plans through their places of work.

The savvy DIY couple steered their wealth clear of investment fees and likely spent only a handful of hours each year “managing” their investments.

SCENARIO 2 – WE’RE A LITTLE INTIMIDATED BY INVESTING: HIS BROTHER SAYS MUTUAL FUNDS

Our second case study comes from PJ & Amanda. This also 28-year old couple are a little intimidated by investing but know they need to get started now. They haven’t heard of low-cost index fund investing or been privy to any financial independence books, blogs or podcasts.

PJ’s brother pointed them in the direction of mutual funds. He says, “it just goes up every year and you don’t need to stress about it.”

This couple again has a lump sum of $10,000 to start their account and will continue to contribute $1,250 monthly across a 30-year timeline.

Starting Investment: $10,000
Monthly Contribution: $1,250
Actively Managed Mutual Fund
Mutual Fund MER: 0.9%
True Return Over Timeline (after fees): 7% – 0.9% = 6.1%

PJ & Amanda net out with over $1,341,982 over their 30-year timeline. The decision to go the actively managed mutual fund route loss them over $240,000 in comparison to Dave & Cindy from Scenario 1.

When it’s all said and done,.their investment fees cost them 4-6 years of retirement depending what their annual expenses and withdrawal rate might be.

SCENARIO 3 – MONEY GIVES US ANXIETY, THIS GUY LOOKS SMART & SPEAKS WELL: “MONEY GUY” APPROACH

Our third case study comes from Robert & Jennifer. This also 28-year old couple (there are a lot of 28-year olds looking to invest) are completely intimidated by investing. The discussion of interest rates, investment fees and index funds gives them anxiety.

“Luckily” Jennifer’s parents have had a “money guy” for the last decade or so. As her Mom describes, “the returns we see are way better than just letting it sit in our savings account. He only charges 1.1%.”

Robert & Jennifer are sold and they now have their “money guy” to lead them to the promised land of retirement wealth. He has ensured them they will be millionaires in 30-years. He invests them into a mutual fund with a higher MER than Scenario 2.

This couple again has a lump sum of $10,000 to start their account and will continue to contribute $1,250 monthly across a 30-year timeline.

Starting Investment: $10,000
Monthly Contribution: $1,250
Actively Managed Mutual Fund With Higher Expense Ratio + “Money Guy” Fee
Mutual Fund MER: 1.2%
“Money Guy” Fee: 1.1%
True Return Over Timeline (after fees): 7% – 1.2% – 1.1% = 4.7%

He wasn’t lying when he ensured they would be millionaires…they just made it.

However, he didn’t tell them he’d cost them close to $570,000 in comparison to a DIY low-cost index fund investor. Their returns are 35.64% lower than those of Scenario 1 all due to investment fees.

They lost a small fortune.

Resources On Index Funds, DIY Investing & Financial Independence

Obviously this case study is filed down to the most simplistic of levels. No diversification, asset allocation, tax considerations, “play money” risk taking, or any of the dozens of other inputs that influence our investment fees and overall financial landscape.

We aren’t taking into account the majority of the “personal” elements in personal finance. Everyone’s financial situation is different and needs to be analyzed to find the most ideal scenario for them. This was simply a dive into investment fees and the influence they have on our potential returns.

The fees associated with your investment choices are one of the few things we actually have some level of control over in the market.

Investing sounds daunting and intimidating, I felt that way and sometimes still feel it. Luckily for us there is a vault of copious knowledge and advice to keep us on the righteous path.

Amazing books, blogs, podcasts, forums, videos and conferences. Check my post The Personal Finance Resources And Content That Saved My Financial Life and my Recommendations page for more suggestions.

All these resources hold the common goal of helping the willing members of the masses to be smarter with their money. That modus operandi of course includes avoiding high investment fees and maximizing your returns.

Books

The Simple Path To Wealth by JL Collins
The Little Book Of Common Sense Investing by John Bogle
Millionaire Teacher by Andrew Hallman
Your Money or Your Life by Vicki Robin & Joe Dominguez
The Bogleheads’ Guide To Investing by Taylor Larimore, Mel Lindauer & Michael LeBoeuf

Blogs, Articles & Posts

JL Collins: Stock Series
Vanguard Blog: The index fund: A monster of efficiency
Vanguard Research Paper: The case for low cost index fund investing
Vanguard: VTSAX Overview (Admiral Shares)
Vanguard: VTSMX Overview (Investor Shares)
Vanguard: VTI (ETF)
Bogleheads: Getting Started
Bogleheads: Investment Planning
Bogleheads: Asking Portfolio Questions
Physician On Fire: 20 Steps To Effective DIY Investing
The Balance: Investing In index Funds For Beginners

Podcasts

See my post for over a dozen personal finance podcasts Top 75 Podcasts To Improve Your Life, Finances, Business, Health & More. In terms of some great interviews with the wonderful JL Collins, check these:

Financial Independence Podcast: JL Collins – The Importance of F-You Money
Financial Independence Podcast: JL Collins – The Simple Path To Wealth
ChooseFI Podcast: JL Collins – The Stock Series (3-part series)

Forums

Canadian Specific Index Fund Investing & DIY Resources

As Canadians we aren’t able to open an individual investment account directly with Vanguard. We need to go the route of using an online discount brokerage to DIY our index fund investing.

The MER %, accounts and general route differ slightly from our neighbours to the south, but the goal is still the same – low cost index fund investing to avoid high fees.

In Closing…

Investing can be a daunting task as you begin your financial journey. However, investing smartly and correctly can be a wealth building lever that sets you up for a successful retirement.

Don’t let investment fees steal your returns.

Arm yourself with the knowledge and understanding to know how and where your money is going. With all the resources noted above and amazing content producers around the the personal finance community, you can master your money.

Here are some other posts to help you take control of your money and life: