The Three Key Factors in Investing for Retirement (Part 1) — Fund Fees
Before we get too deep into investing, we are going to repeat an extremely important point for your success in retirement.
The most impactful factor in retirement success is how much you save as a percent of income.
Aim to save 15% of your income. Here is the link to that discussion.
OK, let’s get back to investing. Because it does matter.
This is the first of three posts on investing.
We hear so much noise when it comes to investing. Sure, it can be complicated. But it does not have to be. The concepts are pretty straightforward. Here are what we consider to be the key, high-level things to focus on:
-Choose low-cost funds
-Choose high-quality funds
-Chose funds that mix together well to form a portfolio
I wonder if the shortness of this list surprises you? Often investing is made to seem super complicated, especially when the message is coming directly from the financial industry. You see, sometimes in that industry, there is not much of an incentive to let you believe that IT IS simple. That’s because folks get paid a lot of money to manage money, and so they don’t tend to boil things down to the basics. No reason they would. But focusing on the three items above will get you where you need to go in retirement.
Why Does This Matter?
With just a few simple steps, you can really accelerate the growth of your retirement savings. On the flip side, by ignoring these three items, it can really create a drag on growth, perhaps forcing you to work longer. Let’s take a look at a simple example.
The stock market returns about 10% per year. Over 30 years, someone saving $10,000 per year can accumulate (theoretically) more than $1.6 million.
Now, let’s say your returns are lower by 1% each year. With a return of 9% instead of 10%, all else being equal, you would accumulate $1.3 million, or a 17% lower account balance at retirement.
And the main items that would cause your returns to be lower, maybe by 1% or maybe by more, are listed above: fees, quality of funds, and asset allocation. The thing is, EACH of the items above could cost you 1% or more. Add them all up and it makes a HUGE difference.
So let’s address them one by one.
Choose Low-Cost Funds
Fund fees are subtracted directly from your returns. So, they work just like the example above, lowering your annual returns and ultimately putting a drag on the growth of your retirement nest egg.
It’s Not Like Choosing a Luxury Car
There is no real correlation between fund fees and performance. Higher cost funds do not generate better returns. It’s not like buying a luxury car, where a high-priced vehicle gives you things like premium engineered engines, computer-controlled fuel injection, heated mirrors and accessories. With cars, it often works to your benefit to pay more.
It does not work like that with mutual funds. In fact, since fund fees are subtracted directly from returns, it’s the opposite. Fees are nothing but a drag on performance. So you will often see higher cost funds show up lower in the performance rankings. It’s pretty straightforward.
Folks Are Already Conscious of Fees
Investors have caught on to this. Individuals have been funneling money away from high-cost funds and into lower cost funds for years. Higher cost funds experienced steady outflows last year, and the year before, and the year before that. While there are still some high-cost funds out there, they are not attracting as many investors as in the past. And low-cost funds continue to gather lots of new retirement savings from investors. Be very conscious of your fund fees.
Here is a widget to help you understand the impact or higher fund fees. Four Factors Demo.xlsx
Fees Can Vary Dramatically
The range between the highest cost funds and the lowest cost funds is dramatic. In the chart below, the three bars represent funds sorted into three groups: High-cost funds, low-cost funds, and the median cost of a fund. Notice a few things:
*Fund fees have been steadily decreasing for years. Hooray!
*The most expensive funds are a full 1.38% higher in cost than the cheapest funds! That is HUGE.
As we showed you above, a 1% difference in fees over a number of years makes a big difference. The average person in the U.S. has over twenty years to save, so the average person is going to be heavily impacted by fees.
Fund Fees Grouped into High, Medium, and Low Categories
Fund fees have been steadily falling for years. At the same time, the gap between the most expensive funds and the least expensive funds is still significant.
So what have we learned?
Fund fees do not link in any way to fund performance, so paying more does not get you more. In fact, paying higher fees gets you lower performance. Fund fees vary widely, so shop around. Fund fees have been dropping for years as investors show a strong preference for low-cost mutual funds. Use the calculator to see how much of a difference fees and other factors impact the growth of your retirement account. Click here: Four Factors Demo.xlsx
Next Up: Choose High Quality Funds. We will show you why it makes a difference, and how to pick good funds.
Friendly request: This whole blog is an endeavor aimed at helping folks improve their retirement situation. My goal is to post content that folks like you find useful in planning their retirement. Please comment below with feedback and think along the lines of “Was this helpful? What else would you like to know? Any burning topics or steps related to retirement planning on your mind right now?” Thanks!
