I’d like to call to order the 1st Annual Elf and Fee Spotters United meeting. Today we will be talking about the latest elf spotting (insert short Trooper jokes here) and paying attention to the fees that are killing your portfolio’s future returns. I would love to say that both elf spotters and investment fees are made up but….. sadly they are not. Elf spotting schools are accepting applications here!
For a humorous spin on the importance of paying attention to what your money is invested in and who is investing it for you PLEASE take the full 20 minutes to watch this excerpt by John Oliver’s show Last Week Tonight. Even if you’re not a fan of John Oliver he is funny and he is bringing up the most important topic when it comes to a secure retirement. Pardon the language! Click on the image!
Now that you can see where the Elf spotting school and certificate came from we can move on to what fees you’re paying.
We have already established that Index Funds are more cost effective and beat their Actively Managed Fund counterparts. The state that I live in and am employed by has done a very good job of limiting fees but if you’re not careful you can easily be taken advantage of by a financial adviser. There are no front-end load options for the deferred compensation plan (457b cousin of the 401k) however, there is a small 0.2% administrative fee. For fee calculations this 0.2% administrative fee is added to the expense ratio that is found within the mutual funds you’re invested in. Expense ratios are the annual fee that you are charged by the mutual fund for operating expenses. Expense Ratios within work sponsored plans, like the deferred compensation plans I have available are, for the most part, what you need to pay attention to. However, if your employer is allowing a financial company to charge a higher administrative fee (like John Oliver’s 1.69% fee) you need to investigate more than just the expense ratio.
Real world example:
I walked in to the financial adviser’s office that the deferred compensation plan had allowed to enroll me.
Adviser: “How aggressive do you want to be and what is your risk tolerance?”
Newbie (me): “No freaking idea…I’m 21 years old”
Adviser: “Fill out this questionnaire that will tell us the answer.”
Newbie: “Will do, thank you.” Unspoken thoughts: You are very nice, I trust you with all my money and I am not going to pay attention to it for the next 32 years.
Adviser: “OK now that you have finished the investment allocation questionnaire, you picked very aggressive/ high risk tolerance. Good for you, we will adjust your allocations accordingly.” Unspoken thoughts: I’m going to put you in 7 different funds that will raise your expense ratio so it is more advantageous to me and makes me more money. You will never realize it because in 32 years you will only see a larger amount of money that has grown slightly over time. Idiot kid… easy money!
Newbie: “Awesome, thank you!” Unspoken thoughts: I HAVE A GUY! I can sleep well knowing that I have a guy that is constantly watching my investments. This is awesome! Look at me go, shoulder back as I walk…. yeah I got this figured out!
Fast forward five years… I started to pay attention and learned more about investing and the mistakes people and I can make.
Coworker #1: Since it was so long ago I forgot all the funds that I was placed in. So, for a recent example I just looked at a coworkers deferred comp (457b) plan through our State. As a law enforcement officer we have a very good pension but with inflation a good pension can start to lose it’s buying power. Therefore the 457b is offered to alleviate where the pension may fall short. So for this example we will use a Trooper who starts at the age of 23 and ends his career as well as his investing in the plan at age 55 (32 years). This Trooper only contributes $150 a month to get the State’s match of $75 equaling $2,700 a year for 32 years. After looking through where his financial adviser had placed his money it was in eight….EIGHT… different mutual funds with fees totaling 6.96%! 10-9 (cop code for repeat)… eight funds total fees 6.96%! I explained to this Trooper that if he would keep it simple and move to just three low cost index funds he could cut his fees down from 6.96% to a measly 0.97%.
Using a free fund analyzer I was able to show the difference between his first 18 years of investing vs the low index fund option. Of course it took me a while because his money was spread out over eight funds, 10% here, 5%, here, 20 % there. It was like a dart board and wherever the dart landed, BOOM we have a high fee portfolio.
$2,700 invested annually for 18 years with a conservative annual rate of return of 8% came out to be…
Dart Board Portfolio = roughly $89,930
Low Cost Index Portfolio = roughly $96,366
Difference = $6,436
You may be thinking one of two things.
- $6,436 over 18 years isn’t bad. I’m fine with that.
2. That $6,436 is in only 18 years, with compounding and opportunity cost he missed out on due to not paying attention does not sit well with me. He has 14 years left during his law enforcement career and many more once he retires!!!!
Still not convinced lets break it down further…
Roughly 60% of his and my investing money goes into Large Cap Stock Funds. The average fee of his Large Cap Funds were 0.83% compared to the low cost index option of .04%. Using 60% of our annual investing dollars to calculate the difference between the two options over 32 years was $31,121 over that time period. Do I have your attention yet? No? Well lets say you get a windfall or decide to pursue an expedited path to financial independence and you max out your contributions to your deferred comp or 401k plan, what does that look like? Using the same scenario as above that would be to the tune of $213,242! DO I HAVE YOUR ATTENTION NOW? Good.
This example was just showing the cost in reference to the expense ratios. This does not factor in administrative fees, front load fees, and as the video pointed out… fee for not knowing there is fees!
As law enforcement we epitomize controlling what you can control; Wear your seat belt, slow down, don’t look at your phone, be vigilant, and pay attention to detail! I cannot tell you how many times a drill instructor screamed at us for not paying attention to detail in the basic academy. Remember the coworker I was talking about in “It’s all Greek to me!” you guessed it… a drill instructor! PAY ATTENTION TO DETAIL, SIR! Control what you can control, control your investment fees!
John Oliver did a great job explaining the fiduciary rule. In my opinion it is a complete conflict of interest for a financial adviser to say he has your best interest in mind when you are put into eight high fee actively managed funds or ANY front load fee fund. Only a select few, like family and close friends, have your best interest in mind besides you. So throw the fiduciary rule out the window or don’t even concern yourself with it because ONLY YOU can spot an elf and all those fees in your portfolio!