The financial advice industry takes advantage of unsuspecting investors in many ways. This is the first in a series of articles about what they do, how they do it, and what you can do to avoid getting caught in the traps that are out there.
At a recent investment summit in Chicago, Steve Forbes, editor-in-chief of Forbes Media, pulled no punches when he explained why Americans are facing a retirement crisis. The problem, he said, is that millions of Americans are losing up to 50% of their nest egg to unnecessarily high fees and expenses.“If you have a 2% fee (not unusual in the investment industry), and you have a 40 year time horizon, that 2% fee will cut your return in half. So if you expect to have $100,000 at retirement, you end up with only $50,000 because of what all those fees have eaten up.”
He went on to say, “So you are really paying not just 2%, over a lifetime, you are paying a 50% fee because of those huge extractions. So again, 2% translates into half, so instead of $500,000 you end up with $250,000. That’s real money, and it should be your money – not somebody else’s.”
In a separate interview, Jack Bogle, the founder of the Vanguard Group, echoed Forbes’ comments. Bogle stated, “Do you really want to invest in a system where you put up 100% of the capital, you take 100% of the risk, but you only get half of the return?”
“One becomes thoroughly disgusted when one looks at the industry and what it’s charging and what it’s giving back, with the value that you’re getting for your investment. I’d do better to stuff my money in a mattress, it would seem, given some of these fees that people are paying,” he added.
If you are a working American, this should absolutely infuriate you. Chances are your retirement account or 401(k) is primarily invested in mutual funds, and unbeknownst to you, Wall Street has been quietly siphoning off large portions of your money.
Fortunately there is a solution, and you can take steps today to avoid these costly fees and other expenses, so that you can salvage your retirement nest egg. I’ll discuss the solution in detail later in this series of essays about the personal finance and investment advice industry. But first, let’s take a closer look at how the industry takes advantage.
We begin by taking a hard look at the most basic investment scenario – the retirement account. This could be an individual’s IRA, a company 401k, a teacher’s 403b, or an entrepreneur’s Keough plan. What all these plans have in common is tax-deferred compounding and a long time horizon.
The basic idea with retirement plans like these is simple. Invest a portion of your income each month, perhaps with a company matching contribution, and watch your nest egg grow exponentially over a very long time period. There’s no need to closely monitor the account, or jump in and out of the market, or try to “beat the market” with complicated and exotic products or trading systems. Just put the money in a small set of mutual funds that represent the stock market, the bond market, and perhaps the precious metals market for those who like a little excitement.
Once the money is invested, there is no need for trading or tweaking except for maybe an annual rebalancing to get back to your original mix of asset allocation. The cost of setting up and maintaining this kind of investment plan should be minimal. In fact, it can be done by a simple computer algorithm.
But that’s not how things work in the real world. The investment industry is bound and determined to make things as complicated as possible, so that they can charge fees and expenses with the dubious justification of maximizing your investment returns while simultaneously minimizing your investment risk. The fees and expenses they impose are often hidden from view and unnecessarily high. Here’s an illustration of how it works.
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This table is from an article written by John C. Bogle, founder of The Vanguard Group, and published in the prestigious Financial Analysts Journal in 2014. He was making the case for using low cost index funds rather than higher cost actively managed mutual funds in retirement accounts. As you can see, the average “all-in” cost of a typical retirement account is 2.27% per year. That may not seem like much, but when you stop to consider that you can get the same asset allocation for 0.6% in annual cost, Bogle’s argument is compelling.
Here’s a table that shows how much that extra expense is costing the average investor over various time frames. At the 40 year mark, expenses consume nearly 40% of the value of the investor’s nest egg.
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So the question every investor must ask is this. Does it make economic sense to give up 50% to 65% of your entire life savings, in exchange for professional advice and management that is no better than low cost index investing that costs next to nothing? Think about that the next time someone tells you that they can help you make more money by following their expert advice.
In the next installment of this series, I’ll discuss another way that the personal finance and investment advice industry takes advantage of unsuspecting investors – obfuscation.