A recent poll measuring the attitudes of individual investors was conducted by nerdwallet.com. The staggering lead statistic reveals that “9 in 10 Americans (92.6 percent) underestimate the 401(k) fees the average household will pay over a lifetime by several thousand dollars. The real average totals over $150,000 per household” (emphasis mine). Long my personal pet peeve, fees are one of the greatest enemies of total return. Barron’s reports a Dalbar study that reveals in 2012 the average equity-fund investor returned 4.25 percent while the market returned 8.21 percent. A significant portion of that underperformance is the result of the manager’s fee.
Consider the Department of Labor’s analysis of 401(k) investment fees: An individual with a 401k balance of $25,000 has 35 years remaining until retirement. That individual pays an investment management fee of 0.5 percent (a conservative assumption) and earns 7.0 percent per year (a reasonable assumption). At the end of the 35-year period and assuming no additional contributions (unlikely and, therefore, conservative), the balance will grow to $277,00.00. However, increase the fee to 1.5 percent (somewhat aggressive), and the account balance grows to only $163,000–or $114,000 less than the portfolio paying the lower fee. According to the DOL, that one percent higher fee compounded over 35-years reduces the ultimate account balance by 28 percent. Fees, it seems, make a difference.
So what does the fee-conscious investor do?
Take a look at exchange-traded funds (ETF’s). Because an ETF is interested in replicating an index rather than outperforming it, the fees are much lower — on average less than 0.20 percent. And because of their popularity, ETF’s now replicate almost any index or industry investor’s might desire. For the ultra thrifty, Vanguard provides a wide array of fund choices and among the lowest fees in the industry.
I was an active manager for over 20 years. I understand the desire to do better than the market. But according to Jeremy Siegel finance professor at the Wharton School, over every 30-year rolling period since 1871. the median return for stocks is 9.22 percent per year. For 20 year rolling periods, the median performance is 8.09 percent. Achieving market returns like these over the long-term while paying fees of less than 0.20 percent will result in a much bigger retirement nest-egg. The kind of return-to-fee ratio that appeals to even the uber demanding investor.