A friend at a party might tell you to buy that hot new stock or IPO. Or the stock market might tank tomorrow and you may want to pull your money out. Or you might be tempted into active management strategies with higher fees. Resist the urge!
Speculation comes with higher risk, and you don't hear from the vast majority of people that lose money chasing higher returns. It is human nature to share stories that paint oneself in a good/smarter light, and so you only hear stories of stock-picking or market-timing from the survivors of the wreckage that is those two activities. This is something called survivorship bias.
The toughest bit about investing is battling your own mind that will constantly tell you to "do something!". Do nothing. Just stand there.
One part of the winning strategy is doing nothing (i.e. staying invested through thick and especially through thin). The second part is doing whatever you can to minimize expenses. This is one of two variables that you control in investing. It is a good idea to invest in Exchange Traded Funds (ETFs) with very low gross expense ratios. For example, SCHB has a ratio of 0.03% — meaning an investment of $1,000 into that fund will cost you 30 cents per year.
I was stunned to learn that most of the funds in 401(k)'s have expense ratios of 1% or higher. In a highway robbery at least you know that you are being robbed! Most people have no idea what 1% of fees can do. It seems so small — hey, it's only 1%! Not so.
Say your long-term return on your investments is 5% (note: the historical average returns in the US market, e.g. S&P, is higher than this). You took the risk and invested your life savings. At 1% fees you are giving 20% of your total life returns to someone who took zero risk. In fact, it is not just the fees, there is an associated opportunity-cost. Your returns would be significantly higher if you paid less in fees, bought more investments that compounded higher over time. The actual cost of that 1% fee to you can be so large as to make your eyes water.
Interactive Investment Fee Calculator
Use this calculator to see the true impact of investment fees on your long-term wealth:
import InvestmentCalculator from '@site/src/components/InvestmentCalculator';
The Mathematics of Fee Impact
Check your investments. Ideally, you should not be paying more than 0.1% in total fees (also called gross expense ratios) on your funds. Also consider managing your funds yourself rather than paying someone else to do it (these fees can range from 0.25%-1% in addition to the fund expenses).
These expenses might seem like a small percentage, but they are a meaningful part of your long-term returns on your investments. These fees keep your balances from compounding in an efficient way, and as such the difference in the ultimate retirement balance between someone paying 1% and someone paying 0.1% in fees is massive.
Why This Matters
Say your long-term return on your investments is 7% (close to the historical average of the S&P 500). You took the risk and invested your life savings. At 1% fees you are giving approximately 14% of your total returns to someone who took zero risk. But it's actually worse than that because of opportunity cost - that 1% could have been compounding in your account instead.
Real Examples
- SCHB (Schwab Broad Market ETF): 0.03% expense ratio
- VTI (Vanguard Total Stock Market): 0.03% expense ratio
- VTSAX (Vanguard Total Stock Market Admiral): 0.04% expense ratio
Compare this to many 401(k) funds that charge 1% or more. Over 30 years, the difference can be hundreds of thousands of dollars.
Use the calculator above to see how fees impact your specific situation. The numbers might surprise you. What fees are you currently paying on your investments? Have you checked lately?