But that's not all! You missed out on what that $58,240 could have grown to, if it didn't get taken out of your account. Had you instead invested in a super-cheap index fund or exchange-traded fund that charges 0.10%, your account would be worth $457,440. In other words, the fees you paid cost you $105,175 - and reduced your account by a third. (“Rats!”) That's the real price of paying “just” 1.5% a year.
Build your own retirement savings, not someone else's
Let's look at it a different way, courtesy of the folks at Flat Fee Portfolios, an advisory firm that believes investors are better served by paying a fixed dollar amount instead a percentage of the account value (known in the industry as “assets under management,” or AUM). In the words of founder Mark Cortazzo, “The AUM fee increases in absolute terms as your account grows [as demonstrated in the table above]. With a flat fee, the benefits of market appreciation actually reduce the fee as a percentage of the portfolio.”
For their scenario, the people at Flat Fee Portfolios assumed:
- Two investors start with $250,000 and want to have $1,000,000 before retiring.
- One pays a fee of $199 a month, the other pays 1.5% a year (billed quarterly).
- The investors earn a compound annual return of 7.74% (the historical return for a mix a portfolio that was 60% stocks and 40% bonds, according to Morningstar).
The results? The first investor reaches $1,000,000 in 20 years, the other in 23 years and three months. In other words, the latter investor has to work more than three years more, while presumably enabling some financial-services people to retire sooner.
Admittedly, paying $199 a month ($2,388 a year) only makes sense if you have a big enough portfolio. But the illustration shows the potential consequences of paying an annual expense of 1.5% versus a fee that starts out at less than 1% and declines as a percentage of the account value.