A Spoon full of costs makes the returns go down

In “Close Encounters with the Market Timers,” I discussed why having your portfolio managed actively may have serious consequences on your returns in the long run. As mentioned previously, actively managed funds generally fail to beat their target benchmarks over long periods of time. There are many reasons for this, but the principal reasons are high fees and costs.

These increased costs come in the form of management fees and fund expenses, which together erode your returns.  Active managers generally charge higher fees than passive managers do because it is assumed that they have more “skill”, which presumably generates higher returns. These increased fees do not lead to higher returns, but to significantly lower portfolio values.

Over long periods of time, thirty years in this case, the difference between total fees of 1%, 2%, and 3% is staggering and has serious ramifications for your standard of living in retirement.

The chart below shows the net growth of $1 million over a 30 year time horizon assuming different fee rates. In both cases, the difference of having a fee that was just 1% higher lead to a return that was 33% LOWER. Moreover, an individual who was charged a 3% fee had a 77% lower return than an individual who was charged a 1% fee.

To increase your returns and financial security in retirement, it is highly recommended that you invest with managers who utilize passively managed funds and who have lower management fees. Fee-based and commission advisors also have hidden fees, so you may want to get a second opinion from a fee-only advisor.

Costs Effect