How Investing Cost Eats Half Of Your Gains

We all love a bargain, but a funny thing happens when we go to buy. Fear kicks in.

What if the product or service we are considering falls short of our needs? What if the outcomes are unacceptable? That moment of indecision is important. It’s the reason branding is so powerful.

Think about a can of beans. Chances are, you grew up in a household where one brand or another of beans was a constant. Today you might pick up the same can without a second thought.

Or do you? Grocery stores have made a huge push into generic products, sold today as “store brands.” The labels are all the same, usually the store’s signature color scheme and logo, whether it’s beans or bacon.

And if you try it once, it’s likely you will find that beans are beans. The store brand is 30 percent cheaper, however, and it makes you wonder: Where does the extra money I pay for branded beans go?

The simple answer is advertising. The more complicated answer is into the pockets of the shareholders of whatever giant food company makes the branded beans.

Money management for retirement is rife with branding. Go into the lobby of a storefront brokerage sometime. The color schemes match the brochures, which match the web site, which match the logos you see on billboards and TV.

All of that branding costs money. It’s meant to assure you of a quality experience. Fear creates indecision, branding reduces fear.

What do you pay for that extra bit of reassurance? Well, quite a lot more than you pay for beans. It’s not a simple markup. Nothing about money is ever simple.

The fees you pay for active money management at the typical big brokerage is a never one-time cost. They are continuous, bear no relationship to performance, and they compound.

An advisor who does fee-only planning or otherwise acts as a fiduciary is one thing. But many investors who use brokerages don’t get this level of attention at all. Yet they pay the fees anyway.

Let’s break it down. Mostly likely, your retirement investing costs are:

Continuous: You probably pay a financial advisor a percentage of your total assets as a retainer, in many cases 1% of your money every year. So, if you have $500,000, you pay the advisor $5,000 each and every year. If you have $1 million, your cost is $10,000 a year. Add to that the cost of mutual funds, and now you’re talking 2.5% or more. Picture $25,000 leaving your account every 12 months. Hurts, right?

Bear no relationship to performance: Had a bad year in the markets? Maybe your portfolio returned nothing at all or lost a little? You still pay the manager. Sure, it’s perhaps slightly fewer total dollars, since your account balance is a bit lower. But it’s still 2% or more of your money. Once you realize that most money managers struggle to keep up with the market, this is a particularly hard fact to swallow.

Compounding: Say you give $10,000 to your advisor this year. Your account is now $10,000 lower and his or her account is now $10,000 higher. Now and forever, that money will be growing in the name of your advisor, not you. That’s how high-cost money managers get rich. They take up to half of your potential long-term gain for themselves.

Half? That’s right. Your advisor is charging 1% and the underlying mutual funds he or she buys for you are charging, on average, 1.5% more. Because of compounding, after 10 years the managers have captured a third of your gains. Stay in for 30 years and it’s more like half.

Stay in for 50 years and it’s closer to 80%. That’s how compounding works. As time passes, the cumulative effect is magnified. The only question is, is your money magnified on behalf of you, or your money manager?