One thing that really frustrates are fees. Banks and financial advisors make a huge living off of fees. You have fees for checking accounts, savings accounts, mutual funds, and even managing retirement. I hate fees and I want to help you save on those pesky fees.
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Fees on Retirement:
The other day, I was taking a look at my wife’s retirement fund in Australia. It is called Superannuation. The Super is basically the 401K equivalent in Australia.
Getting some documents from my father-in-law, and I looked confused as if there were a bunch of fees being taken out with not much growth going on. So I decided to investigate.
Her investments were in a Balanced portfolio, which was getting a return of 4.31%-6% per year. The 10 year average was around 6.53%. The fees are what got me to think. There were three types of fees. The administrative fee of $67, the portfolio fee of 0.54%, and a fee of 0.10% of the overall portfolio. The fee was basically $67 + 0.64%.
Those fees were taking a good chunk of money from my wife’s retirement. I wondered what the investments were. As I noticed, the investments were being managed and had indirect cost fees, performance fees, and other performance fees.
Let’s just say it was costing more for her to keep her money in this fund than to move it to a better fund with less fees.
“Rule #1: Never Lose Money
Rule #2: Never Forget Rule #1″
There are two different types of fees that can been seen on investments. You have the administrative fees that can be charged by the financial advisor and even the investment company, and you have the expense ratios and the cost of trading certain investments.
The good thing is that fees with trades have basically been eliminated in the U.S. With new technology and apps offering $0 to make trades the big investment companies had to stay competitive. So there are not many companies that charge a fee for trades in the U.S. Most have gone down to $0.
A lot of companies still charge an adminstrative fee. There can be a fee for hosting the 401ks and even the Australian Super. These fees are typically lower, but still a fee is a fee, and no one likes to pay extra money.
Expense ratios are another way for the investment companies to make money. The expense ratios are usually levied on mutual funds for the management of the funds. The companies will take their cut from your earnings and you will never notice the money missing.
My brother shared with me the many mutual funds that his 403 (b) had. It was full of mutual funds charging on average between 0.60%-0.9% for the expense ratio.
To make these numbers make sense. Let’s say you have a $10,000 investment. At a 0.6% expense ratio you would be paying the mutual fund company $60. For every $10,000 you owe the company $60.
That may not seem like a lot now, but as your nest egg grows so does those fees. At $1,000,000, that expense ratio is sitting at $6,000. That is a good chunk of change there.
Financial Advisor Fees:
Financial advisors are those nice people that help you plan out your finances. There are some great people out there that can help you make financial decisions. Oftentimes, these people do a great job for you. What you should watch out for are the fees that are involved?
These fees come in different ways. You have those financial advisors that get paid a percentage of your portfolio. These guys are the ones you want to stay away from.
It doesn't matter if your portfolio goes up or down. They will still get paid. These are basically commission based financial advisors. The average fee for them is around 1%. Plus whatever funds they give you will have another fee like an expense ratio, which will just eat away at your money.
Then there is the fee-based Financial Advisor. These guys are the ones that you have a prestated fee for their services. The commission-based Financial advisors are the ones that take a percentage of your portfolio.
If you are looking for a financial advisor choose a fee-based. The commission-based ones are salesmen. They will get a percentage no matter how it does.
Index Funds for the win
Index Funds to me are the easiest way to create wealth. It matches the market, has low fees, and even the smart guys like Warren Buffet suggests them. So why don’t people use them?
Most people do not know what they are investing in. They have a 401K, maybe an IRA, or some sort of retirement vehicle and have no idea what is in it. There is the hope that when they retire they have enough money in it. This is the part that banks and investment companies can take advantage of people.
The banks and investment companies will make sure these people invest in mutual funds that are actively managed. These managers if they are good can get some good returns for a few years. That warrants them to keep collecting those fees, but no one knows what the future holds. 85% of active managed mutual funds underperform the stock market after 10 years, and 92% after 15 years
So you have a fund underperforming the overall stock market. Plus the fee is close to 1%. So it costs you more money to lose money. Then why do people do it? They are selling a product.
Index Funds saving on fees
John Bogle in 1975 decided to make investing easy for the average American. He came up with a mutual fund that is not actively managed, but it matches the stock market index. These are what people call Index Funds. Their expenses are rock bottom low. They beat the managed funds, and you build some great wealth off of them.
VTSAX costs 0.04% on their fund. When you buy it, you will own a piece of 3500 companies in the U.S., which is the total stock market. It has been averaging close to 15% over the last 10 years.( but for a conservative perspective, you should expect a return close to 7%.) At $10,000 it costs you just $4. If an actively managed mutual fund has a cost close to 1% that would equal $100. Do you want to pay $100 or $4?
Back to your nest egg of $1,000,000. At a 0.04% expense ratio, the index fund would cost you $400 a year. The fund my brother has would cost $6,000 a year. Which one would you rather have?
The winner is the Index Fund. They are cheaper and they have a better performance in the long run.
“Before costs, beating the market is a zero-sum game. After costs it's a loser's game. Fund performance comes and goes. Costs go on forever.”
Banks can get a big notorious with bank fees. You have overdraft fees, minimum balance fees, and any other fees. First of all, you are giving your bank money so they can lend it to other people. They should not be charging any fees, and if they do, take your money, and look for another bank without fees.
I bank mostly with Ally Bank and Charles Schwab. Schwab gives me ATM fee free withdrawals all over the world. No fees on ATMs. Ally gives me fee free banking. It is not like Bank of America or Wells Fargo that may charge you for not having automatic deposits in every month or even a minimum balance. That is just Bull S$%@.
It is your money. Find a bank that offers you something for free.
Why do fees matter?
Fees are something that sucks your retirement dry. The amount of money that can be working for you is constantly going out the window to the financial advisors or the banks that are selling some of these products.
If you are paying 1% for a financial advisor to work for you, then you are giving away 25% of your retirement fund. How did I get those numbers? Easy, using the 4% Rule, which gives you 4% as a safe withdrawal rate for your retirement. If you pay 1% for fees you will need to have more money for retirement since you will need 5% instead of 4%.
Let's do some math. If you need $40,000 per year in retirement that would equal to $1,000,000 for your retirement nest egg. If there is a 1% fee on those investments and more going to a financial advisor then you will be paying $10,000 each year. Now you are down to $30,000 per year.
You will need to have 33 times your annual spending instead of 25x your annual spending. That means you will have to work longer in life.
The lower your fees are the more you save.
My Wife’s retirement revisited:
I had mentioned that my wife’s SuperAnnuation had lots of fees. Doing some investigating, I moved her portfolio from a Balanced Option with 0.65% of fees to an Index Balanced option that had 0.10% of fees. The Balanced Option in the last 6 months averaged returns of 7.81%, but the Index option had 14.62% in returns. Like I said, I like Index Funds.
The End to Fees
Fees are something I dislike. As I was reading the book, Quit like a millionaire, Kristy Shen (the author) mentioned a story of her in the bank and how the bank salesman was more like the modern bank robber than someone that was actually robbing the bank. The salesman steals your money through fees that you may not even know about.
Just knowing the fees you are paying is one step closer to making a difference in your financial future.
Take a step today, see how much fees you are paying. Find either cheaper funds or even a better financial advisor. Look for a better bank. It is time to save some money and take control over it..
” Spend less than you make, stay out of debt, and invest the rest”
I’m Steve. I’m an English Teacher, traveler, and an avid outdoorsman. If you’d like to comment, ask a question, or simply say hi, leave me a message here, on Twitter (@thefrugalexpat1). Many of my posts have been written to help those in their journey to financial independence. I am on my journey, and as I learn more I hope to share more. And as always, thanks for reading The Frugal Expat.