Investment fees are pretty bad.  I’m not going to lie to you about that.  I initially planned on asking a hypothetical question about whether or not they were a big deal, but they are.  They are a big deal.  They are such a big deal I don’t even want to waste time asking how your week was.  We just don’t have time for that.  If your portfolio is being charged a few percentage points per year, you could be losing out on over a million dollars over the course of your life.

I can see you’re already bored with the topic of investment fees and losing out on a million dollars so I’m going to briefly, and seamlessly, segue into a slightly different topic.

Little Known Fact: Apparently, it's spelled segue, not segway. English, man.

Before we get into the exciting world of investment fees, let’s talk about something fun.  Your money is going to double every few years for the rest of your life. Yippee!  We all like to see our money double, right?  There’s a pretty simple formula to figure out how long that will take.  It’s called The Rule of 72.  Even I can’t really spend an entire article dragging out a single formula, so I’ve combined it with my rant, I mean comparison, of typical financial advisor fees vs. Index fund fees.

It’s amazing how much longer it will take you to reach your financial goals if you’re being charged fees through a financial advisor. The charts below should be enough to convince you that investing in low-cost index funds with places like Vanguard or Charles Schwab is the way to go…Or is it? Yes. Yes it is. Sorry, I just can’t take suspense.

The Rule of 72- How Many Years Before Your Money Doubles?

First on the agenda, The Rule of 72.  How many years will it take for your investment portfolio to double?  The Rule of 72 is a formula for figuring just such a question out.  Money Chimp has an easy-to-use calculator  that I found after doing all these calculations by hand.

All you do is take 72 and divide it by whatever investment return you want.  For example, say the stock market returns 10% per year.  In this scenario you take 72/10 which equals 7.2.  If the stock market returns an average of 10% per year then your money will double every 7.2 years.  Isn’t that fun?

“We Want Examples! We Want Examples!”- Children Chanting

Let’s say you have $100,000 saved up and you want to know when you’ll become a millionaire but you don’t want to invest any further than your initial $100,000.

Side note: Why? Why would you hypothetically stop investing? Come on, man. I mean, ugh. So frustrating.

Anyway, the first step we have to do is pick a realistic number we think the stock market might return.  You can also do an unrealistic number if you want.  It’s Friday, do whatever you want.  You can pick several numbers and see how each plays out.  First we’ll say 10%.

So we’ve got $100,000 and we’re assuming a 10% return per year.  First, take 72 and divide it by 10, which equals 7.2.  It will take 7.2 years for your money to double.  In 2018 you have $100,000.  In 2025 you now have $200,000.  By 2032 your money will be up to $400,000.  Isn’t this starting to get fun?  In 2039 your money will be $800,000 and you’d cross the million dollar marker in 2043. Woo!  At the end of 2046 your portfolio would be sitting pretty at around 1.6 million dollars.

Now, the market won’t return 10% per year, every year.  This is just an example.  You can pick any number and see where you’ll end up.

“We Want Another Example But This Time With 5% Assumed Instead of 10% Assumed!” – Again, the children chanting

Ok, kids.  Instead of a 10% return on investments we’ll assume a 5% return.  The equation would be 72/5= 14.4.  In this scenario your invested money would double roughly every 14 1/2 years.  You have $100,000 in 2018 which turns to $200,000 by 2032.  That $200,000 turns to $400,000 by late 2046.  In 2061 you’d finally have $800,000 and you wouldn’t cross that million mark until 2065.

Notice how much of a difference there is between a 10% return and a 5% return.  Over the same amount of time from 2018-2046 a 10% return had an ending balance of 1.6 million dollars where a 5% return had an ending balance of only $400,000.

This striking difference between a 5% return and a 10% return is partly why we’re so adamant about paying the lowest fees possible with index investing through Vanguard.  If you’re paying 5% in fees to a financial advisor it’s essentially cutting your return from 10% to 5%.  People don’t believe how badly fees affect the long-term performance of their funds.

[You may not have noticed but we’re back to talking about fees.  This is where your million dollars comes in]

Let’s use the following as an example:

3% Financial Advisor Fee vs. 0.04% Fee Investing Through Vanguard

I’ve got a good friend who has a financial advisor who charges him 3% on his investments.  When my buddy told me this I spit out my lunch and exclaimed, “He’s robbing you blind! Run for the hills!” He responded, “No, it can’t be that bad.  Is 3% bad?” He said he knew it wasn’t the best use of his money but it couldn’t be all that bad could it? His financial advisor told him, “You tip a waiter 20% don’t you? I’m just taking 3%. What a deal, huh?”  I want to slap his advisor in the face with a fish.  Sadly, I have no fish.

My friend is a good guy who is working hard for his money. It makes me sick watching people I know being taken advantage of.  This is a real calculation of the difference in my friend’s portfolio over a 30 year period if he stuck with his “advisor” versus investing in low-cost index funds.

Person A with an Advisor vs. Person B with Vanguard

We’ve got two people, person A and person B.  Each of them invests $100,000 chunk of money into an account and they let it sit there for the next 30 years.  We’ll assume each person earns 10% returns compounded.  Person A earns 10% but their financial advisor charges them a 3% fee.  Person B earns the same 10% but they go through Vanguard and are charged a 0.04% fee.

After 30 years, how much less money does person A have than person B?

a) $10,000 less

b) $100,000 less

c) $1,000,000 less

What do you guys think? Did you read the title of the article? Here’s how the numbers play out:

As you can see from the chart above, person A has almost $1,000,000 less in their portfolio because of fees of only 3%. YIKES!!? That can’t be right. I don’t believe it.  If you’re invested in funds that have fees, and you’re too lazy to get out of them, hopefully this chart will wake you up.

These charts don’t mean anything to me. If I were reading this article I would probably glance over them. I need to be able to play with the numbers myself.  This fee calculator will let you play with numbers till your heart bursts with knowledge.  If I was reading this article I would click on that link and probably subscribe to this blog.

“But my financial advisor says he can beat index funds! He wouldn’t charge all that money if he wasn’t good.” – Poor sap being taken for a ride

Picking individual stocks is a guessing game; and everyone is guessing.  Few throughout history have been able to do it proficiently for any length of time.  On the flip-side investing in index funds is totes easy.  You just need to spend 10 minutes setting up a Vanguard account and you can save yourself an incredible amount of money over your lifetime.

I’ve already posted this but it can’t be repeated enough.  The greatest investor of our time, Warren Buffett, made a 10 year bet that someone investing in index funds would outperform any hedge fund manager’s investments, fees included, over a 10 year period.  Needless to say, he won in a landslide.  Your financial advisor can’t outperform index funds, especially once you factor in their fees.  If they could, they would’t be advising you.  They’d be rich and famous like Warren Buffett.

Here’s the entire chart so you can see I used the exact same numbers and time frame and also because I just learned how to take a screen shot…I’m no renaissance man.

 

Can you believe it?!  Mr. Burrito Bowl knows how to do screen shots.  ‘Bout to get wild, folks.

I hope this fun Friday post has been informative and a breath of fresh air.  Play with the calculations and daydream about how much money you’ll have if you stop wasting it and instead start investing your hard earned cash!

What we learned:

The Rule of 72: How many years it will take for your investments to double.

72/Investment Return= Number of years before your money doubles.

Fees: Not good, man. Not good.  Fees of just 3% could be the difference of over a million dollars over a 30-year period.  Invest in low-cost index funds.

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