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?
I 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.
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.
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:
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.)
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.