Investment costs and taxes are two well-known features of investing money. The impact of taxes is a familiar expense unique to each investor, while the impact of investment expenses is more opaque requiring diligence on the part of the investor in order to minimize costs consistent with their investment objectives. The investor cannot control the market, but they can control the cost they pay to be in the market. Because fees and expenses, stated and hidden, impact investor outcomes because they constitute an ongoing drag to the performance of the investment.
Consider the following simple examples.
$100,000 invested for 10 years at 8% with no expenses will yield $215,892.
$100,000 invested at 8% for 10 years with 1% expenses will yield $196,176.
$100,000 invested at 8% for 10 years with 2% expenses will yield $179,630.
The difference between zero expenses and 1% expenses over ten years is $19,176 ($215,892-$196,176 = $19,177) or 8.8% less money. The difference between zero expenses and 2% expenses over ten years is $36,808 ($215,892 – $179,630 = $36,808) which is 17.04% less money compared to zero expenses as a result of negative compounding of investment costs.
For the investor who has the time and temperament to manage their own investments, reduced fees can be an advantage in the purely mathematical sense. Those not willing to base their retirement or other important financial goals on their individual skill sets or their emotional ability to tolerate the swings in the markets over time must consider how the impact of higher costs associated with investment services and advice will impact their investment goals.
Meaningful guidance can be a major advantage for people who do not have the time or expertise to be full time managers and planners of their financial lives. The fees they pay can be considered a valuable investment that can possibly help them secure their financial goals over time, but it is up to the individual to understand how much they are paying related to the direct and indirect costs of investing.
This is a hypothetical example and is not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.
Investing involves risk including loss of principal.