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How to Beat Wall Street: Keep Investment Costs Low

Compound interest has a magnifying effect. It amplifies the benefits of a good plan, but also the malefits of a bad plan.

Let's take a simple example. Suppose the stock market will return exactly 6% annually for the next 20 years. At that rate, compound interest will turn $100,000 into $320,714.

 

 

But now suppose you invest in the market through a mutual fund that charges an annual fee of 1%. That fee sounds small, until you realize that it decreases your return rate from 6% to 5%, and reduces your final balance by a huge amount.

 

 

The difference between what the market gives and what you get is more than $55,000 - way more than what the 1% fee would make you expect. (And who keeps the fifty-five thousand? The people who charge the one percent fee, of course. They love compound interest as much as you do.)

 

 

An annual fee of 1% sounds small, until you realize that it's significant in proportion to the annual return of the market, so it causes you to lose a significant amount of money.

 

Low Cost Index Funds

This discussion was just academic until 1976, which is when John C. Bogle introduced the first practical low cost index fund, known as the Vanguard 500 Fund. It invested in the S&P 500 index, and charged the then unbelievably low fee of 0.46%. Competitors called the idea "Bogle's Folly" - why give investors a break they didn't know they deserved?

Today, Bogle's fund is still going strong, charging a lower fee than ever. And competitors have offered index funds of their own:

 

FundLoadFee
Vanguard 50000.17%
Vanguard 500 (etf)00.05%
Fidelity Spartan 50000.09%
iShares Core S&P 500 (etf)00.07%
Brand X5%0.99%

 

("Load" is sales commission.)

 

Beware Brand X!

The table shows four excellent funds, and one awful one. Just because it's an index fund doesn't guarantee that it's low cost. You want a load of zero, and low fees similar to the first four funds shown.

 

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Investing 101

 

 
Also See...

Mutual Fund Expenses