Check the fees on your retirement portfolio, it could save you a ton

The title of this story assumes you even have a retirement portfolio. If you’re like me, you perhaps haven’t given as much thought to your retirement as you should. And, if you’re like me, once you did start thinking about it, you started to get awfully scared.

We are not our parents. And many of us will not have pensions that provide for us and our spouses in our retirement years. There was a really interesting, and scary, opinion piece in the NYT back in 2012 by Teresa Ghilarducci, a retirement policy expert, walking us through just how bad the situation is for new retirees.

Ghilarducci says that “seventy-five percent of Americans nearing retirement age in 2010 had less than $30,000 in their retirement accounts.”

What does that mean? “Almost half of middle-class workers, 49 percent, will be poor or near poor in retirement, living on a food budget of about $5 a day,” Ghilarducci adds.

Want to hear a scary number? By the time you retire, your retirement accounts needs to have roughly 20x the amount of money you want to take on a yearly basis. So, if you want to live on $50,000 a year, you’ll need to have $1,000,000 in your retirement account by the time you retire.  (Now, that number can go down, potentially, if you’ve already paid off your house, for example, or if you have a partner who also has retirement money coming in.)

The thing is, how many people expect to have $1 million socked away in their IRA by the time they retire?

money2I learned the hard way that you need to start thinking about these things now.  I had always been told to stop paying attention to the ups and down of your IRA. The market is always going to have a great year and a lousy year, and if you’re saving for the long-term, you just need to ignore it. So I did.

Big mistake.

What happened was, over the last three and a half years, during one of the biggest stock market recoveries in history, the amount of money in my retirement portfolio didn’t change much.  That’s in spite of the fact that I put the maximum amount of savings that I could every year into my SEP-IRA — I’d have had more money had I just put those contributions in the bank — and in spite of the fact that the market went up around 50% between then and now.

I checked out a neat historical calculator and figured out that had my money simply gone up with the market average from January 2011 to December 2013, I’d have seen my nest egg increase 50%.

Just take last year. “My guy” made me around 1.8% on my investments. The 403b that I forgot I even had, from a job nearly 20 years ago, which has been on auto-pilot for nearly two decades, grew 30% from January to December, while the market overall grew 27.7% — yes, I beat the market by forgetting I even had this account. (And while you shouldn’t just look at one year, or even a few year’s returns, when you have a huge bull market that’s been going on for years, and you’re still behind, it’s time to think about moving your money.)

So, I fired my retirement guy (after confirming with some experts that my portfolio should have not have lost a lot of money over the past 3.5 years), did a lot of reading, and want to walk you through a few of the Financial 101 lessons I’ve already learned (things that are apparently “obvious” to financial people, but which to me were a surprise). In this post, I’m going to deal with the first big lesson: “fees.”

There are a ton of fees that you’re potentially paying for the right to put your broker’s kids through college. And they’re fees you don’t necessarily have to be paying at all.  And, believe it or not, over 20 to 40 years, those fees add up to a LOT of money, far more than you’d believe.

The SEC walks you through the various possible fees. But they can include fees your broker charges for managing your money, fees a mutual fund charges you to buy it, fees you pay each year for the right to remain in that mutual fund, and much more.

Rick Ferri, who is one of the more respected financial guys on the Web, walks us through some of the fees, and what those fees are really costing you. Rick says that the typical investment adviser charges you 1% per year on your first $1 million dollar of assets. That means if you have $100,000 in your IRA, your broker is costing you $1,000 a year off the top.

But you’re not just paying your broker. You’re also paying fees to the mutual funds you invest in.  Rick says the average mutual fund fees could be 1.1% per year. So together, you’re paying 2.1% per year of all the money in your IRA to your adviser and others. And it doesn’t matter if you make money that year, or lose money that year, on your investment — you’re still going to lose 2.1% of the amount in your IRA to fees.

You might not think 2% sounds like much, but since you’re hoping to average somewhere between a 6% and 8% return per year, taking 2% off of that is a lot.

Let’s see how much money that actually is.  Let’s say you have $10,000 in retirement savings. And let’s say you lose 2.1% a year in fees. How much money are you losing over 20 years?  The chart below shows how much money you’d lose if your investment grew at 6% per year and at 8% per year.  The second chart shows how much money you’d lost over 20 years if you started with a $100,000 investment.

by-default-2014-06-15-at-10.12.56-PM

Yep, you’d lose 1/3 of your profits if you were paying 2.1% annually in fees. 

Now, let’s compare this to how much I pay with my new brokerage firm, Vanguard, and with the low-cost index funds that I’ll be buying.

The fee on the core index fund I’ll be buying at Vanguard, the Total Stock Market Index Admiral, is 0.05% per year. Yes, that’s 0.05% vs the average fee of 2.1% that others might be spending elsewhere.  This is why it’s important to not just look at the various brokerage houses you can go to host your retirement money, but also to check out the expense ratio (the fees) of the various things you’re invested in.  You might find a huge different in fees between one fund and another. (In a future post, I’ll talk more about these index funds and why they’re (possibly) a very good idea.)

But there’s another advantage of hosting my IRA at Vanguard, I’m not paying 0.05% per year on my total holdings. I’m only paying that fee on my profits. Vanguard gives an example of the kind of money you save when using them versus other brokerage houses. Here’s what you’d pay in fees if you invested $100,000 over 20 years, with a 6% annual return, in an index fund at Vanguard versus the industry average fees for similar index funds. Note that Vanguard’s fee for this fund is 0.19% while the industry average is 1.08% — so we’re talking less than 1% difference in fees:

vanguard

Yes, that less than 1% difference in fees saves you $50,000 over 20 years on an initial investment of $100,000.  That ain’t nothing.

Now, the fees are incredibly complicated at a number of firms, but not Vanguard, which is why my “friends who know more than I” sent me there.  (And keep in mind that I’m looking at a tax-deferred IRA — you’ll pay transaction fees if you’re investing in a taxable account, whereas I don’t pay anything for most of transactions in my Vanguard IRA, though I do pay an annual fee on the earnings. So there are a lot of details to delve into.)

In spite of the details, overall you can save a lot of money if you keep an eye on the fees.  (Now, depending where your retirement monies are, you may, or may not, be able to roll them over to somewhere like Vangaurd. I have a SEP IRA, a traditional IRA and a 403b, all of which I can move, and am moving, to Vanguard in the next few weeks. But if you can’t move your portfolio, at least check the fees on your various investments where you are, and take them into account when choosing your investments.)

More from Rick Ferri on fees:

Investing in actively-managed mutual funds that charge high fees can lower your standard of living in retirement by as much as one-third over a low-cost index fund strategy. This is the conclusion of Nobel Laureate William Sharpe in his latest Financial Analysts Journal article The Arithmetic of Investment Expenses….

Using Morningstar data, Sharpe found the average actively-managed U.S. stock fund had an expense ratio of 1.12 percent during 2012. The Vanguard Total Stock Market Admiral Shares (VTSAX) with an expense ratio of 0.06 percent was selected as his market index fund proxy….

Sharpe’s conclusion echoes that of many academics and authors as well reinforces his own previous work, “the odds are even that an investor in the low-cost fund will be well over a third richer than an investor in the high cost fund after 30 years. But there is a small chance that an investor in the low-cost fund will regret not having selected the high-cost fund. For those who choose funds with high expense ratios, hope may spring eternal.”

In a future post, I’ll tell you what I learned about these low-cost index funds, and why you could very likely make more money investing in a low-cost fund by yourself than you’d make with some high-priced broker.

You can use this very cool fund analyzer to see how much money your investments are costing you.

Here’s more on Vanguard’s fees.


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Follow me on Twitter: @aravosis | @americablog | @americabloggay | Facebook | Google+ | LinkedIn. John Aravosis is the editor of AMERICAblog, which he founded in 2004. He has a joint law degree (JD) and masters in Foreign Service from Georgetown (1989); and worked in the US Senate, World Bank, Children's Defense Fund, and as a stringer for the Economist. Frequent TV pundit: O'Reilly Factor, Hardball, World News Tonight, Nightline & Reliable Sources. Bio, .

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  • http://AMERICAblog.com/ John Aravosis

    Just watched it, it was great – thank you.

  • http://AMERICAblog.com/ John Aravosis

    That’s very well done.

  • http://AMERICAblog.com/ John Aravosis

    Ah ok, I was sure he told me by phone that it was just on the revenues, which surprised me. I’ll ask again, but your way sounds more sensible. Still, 0.05% is a lot less than the 1% my now-fired broker just charged me to liquidate my IRA assets before rolling them over to Vanguard.

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  • bejammin075

    Index funds are certainly the way to go for stock investments. I can prove this with a simple thought experiment, followed by a few assumptions.
    Consider the entire universe of stock investors, and divide them into two groups. The Index Investors and the Active Investors. The average return of the entire universe of stock investors is X (before taxes and fees). The Index Investors therefore make X, because they make the average. The rest of the investors, the Active Investors must also make X, for the average to be an average. This is the key part of the arguement, so I hope that make sense.
    Now factor in the costs to the Active Investors: extra management & brokerage fees (Fund Manager needs new yacht), extra taxes (from frequent trading), etc. Taking into account the extra fees, the average Active Investors will make substantially less than the average Index Investor. Not only do the Active Investors make less, but they work harder to make less (because investing in index funds is so easy).
    Lastly, it’s only the average Active Investor that makes X (before taxes and fees). There are some active investors who will consistently beat the market, and some of them beat it by a lot. They are Wall Street Insider types, and you do not have access to them or their “talents”. Taking into account the inaccessible Wall Street Insiders who consistently make more than X, the “average” Active Investor will make less than X, and then pay extra taxes and fees.

  • robertvax

    > I’m not paying 0.05% per year on my total holdings. I’m only paying that fee on my profits.

    Well… no, the 0.05% expense ratio is paid on your total assets under management, not just on your profits. Even if the fund loses money in a given year, Vanguard still has to collect and pay its administrative costs for administering the index fund.

    One way to think of it is that the fund will return 0.05% less than the raw index itself. So if the index goes down in one year and returns -2.0% (negative two percent), then the fund will have -2.05% returns for that year. If the index goes up by 5% in a year, the fund will return 4.95% for that year.

    But .05% on total assets managed is still really low. On a $100,000 portfolio that’s $50/year, which seems pretty low to me given that Vanguard handles all of the internal rebalancing to keep tracking the index.

    – RV

  • RobT

    Doing a project on this right now and we’re using this ad to show people what’s up. https://www.youtube.com/watch?v=aquGVFkFi7k I don’t endorese FeeX. Just a sampling of new ways to go.

  • http://musephotos.wordpress.com/ GarySFBCN

    Yes, after investigating the funds. It was good for me, because I needed more regional diversity in my holdings.

  • http://AMERICAblog.com/ John Aravosis

    Now, I do think that, already after having done a ton of reading on this to educate myself, you need to educate yourself or you will risk all of your money by doing it yourself. I’ve been surprised to read, repeatedly, investment advice couched with “even though you really should invest in x, you have to do it over the longterm, hold it for 20 years, and because the market in x is too volatile, and most people will freak during a downturn and then sell the entire investment low, when they should just hold it and wait it out, that’s why you shouldn’t buy x.” In other words, a wise financial move will be ignored by people when the market, or the investment, heads temporarily south. I’m buying index funds, and I’m planning on holding them for 20 years (15 if I’m somehow lucky and manage to make a lot more money between now and then). So I’m ready for the market to tank, as I was ready in 2008/09, when I ignored how much my portfolio lost. I didn’t care as I had another 20 years to catch up. Now, that I lost out on the recovery, big time, I care.

    I also think there needs more education so that people understand what fees they’re actually paying, to the brokers and to the funds, and what their options are. I just figured my broker knew what he was doing, and there were no real alternatives. I was wrong.

    And finally, as you know, there are a slew of recent studies showing active (managed) mutual funds doing worse than index funds that are basically on auto-pilot, and are much cheaper. I believe the average is someone on the order of index funds beating 80% of the comparable actively managed funds. I’m open to hearing why that’s wrong, why someone shouldn’t just invest in the S&P or the total market (if they have 20+ years to go). But the argumehnts out there are compelling for just going index, and then of course getting some advice as to how much equity vs bonds, how much domestic vs intl, how your allocation should change between now and as you approach retirement, etc. And, if you’re not in an IRA, then you need to learn a bit about tax efficient funds as well.

    So there is a lot to learn, I don’t deny that. And just moving your money and not doing the research might not bode well.

  • http://AMERICAblog.com/ John Aravosis

    You’re kidding — you invested based on random scribbles? But of course, it did work!

  • http://www.americablog.com/ Naja pallida

    Pretty standard rule for talking to your bank, your insurance agent, your financial advisor, your doctor… if you ask a straightforward question, and they can’t give you a straightforward answer, or mock you for asking, you should be looking for a new one immediately. You’re being scammed. :)

  • http://musephotos.wordpress.com/ GarySFBCN

    You seem very competent and conscientious. Sadly, after decades of trying to find someone who isn’t trying to sell me junk, who doesn’t boast about how they have over 20 years of experience and never listens to a word I say, who recognized that living in two different countries does have special considerations and that because that isn’t their field of expertise it doesn’t work for me, who doesn’t look at me like I’m from Mars when I say that I want to pay my fair share of taxes (as everyone should), who didn’t have an office full of furniture that costs more than my home, I gave up. None of them could abide that I am very conservative regarding risk. And this sad group includes both fee based and commission-based advisors.

    Interestingly enough, a good investment I made was a real gamble. A large envelope arrived in the mail from American Funds. On the flap side of the envelop, someone scribbled something as if they were jotting down notes from a phone call. They were all ‘ticker symbols’ of mutual funds and ETFs. As a gamble, I threw some money into two of the funds and they have both done very well over the years, better than most of my American Funds investments.

  • Steven in Charleston

    One of the biggest misconceptions people have about Financial Advisors is the belief that generating a particular return is all we do. Certainly that is PART of what we do, but it is just a part. A second key element that is often overlooked is that we help manage risk. The market did very well this past year, and lots of do-it-yourselfers are patting themselves on the back and talking about how foolish their peers are who pay full-freight to a financial advisor. But most of these “independent” investors don’t understand the amount of risk they are absorbing while they “ride the wave.” A knowledgeable advisor will take the time to understand how much risk you are comfortable absorbing, and will then create a portfolio designed to generate the maximum result within those parameters. A second element of the job of a knowledgeable advisor is understanding how to incorporate non-investment components such as taxes and insurance into an over-arching financial plan. There is an equilibrium that can be reached in both instances, but finding that balance requires a level of financial sophistication that most people who don’t do this for a living do not have. And finally, a key role of an Advisor is helping to develop a plan that is customized to YOU. Calculators and rules of thumb are fine to get your started, but every person’s situation is unique. Crafting a plan – and then modifying it as life “happens” – is fundamental to long-term success. And, of course, there IS the issue of return. The “save the fees” model only works if you actually ~can~ generate the same results as a professional manager. I understand that you have had a bad result with your previous manager. I don’t know the details – it is possible that he is just a “bad apple” – they exist in every profession. But by and large, our profession does a very good job, especially when taken over a long period of time. One final thought – there are a lot of people with a few hundred thousands dollars choosing to manage their own nest egg, but you won’t find very many multi-millionaires taking the do-it-yourself route. These folks pay their advisors tens, sometimes hundreds of thousands of dollars a year to craft a plan and keep it on course. They wouldn’t be doing so if they didn’t clearly understand that they are getting much more than they are paying.

  • http://AMERICAblog.com/ John Aravosis

    My cousin told me to ask mine, and all I got was gobblygook. Told me he was doing it for free, or something, and that I couldn’t afford his real advice. SO glad to be gone :)

  • http://AMERICAblog.com/ John Aravosis

    Oh wow, Id never seen those videos, that’s great! I can see what I’m going to be doing late nights this week :)

  • RetirementLiving

    Also check what your financial advisor is charging and how he is compensated. There is a good post about this on the site Retirement And Good Living. The site also provides information on retirement planning and investing and many other topics including finances, health, retirement locations, travel, part time jobs, volunteering and more.

  • WeiQiang

    This issue was also explored on ‘Frontline': http://www.pbs.org/wgbh/pages/frontline/retirement-gamble/

    Ever since I saw it, I’ve researched all my own funds, changed funds where it would help, and pleaded with family members to stop throwing away money. It won’t surprise anyone to know that 401(k)’s weren’t created for the benefit of employees. They were developed as additional revenue streams for financial services firms.

  • Indigo

    Or, for Midwestern poise and modest calm, talk to your local Edward Jones rep.

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