The wonderful magic of compounding returns that is reflected in the long-term productivity of American business, then, is translated into equally wonderful returns in the stock market. But those returns are overwhelmed by the powerful tyranny of compounding the costs of investing. – Bogle (The Little Book of Common Sense Investing)
There is such an intense focus on what returns an investor earns that often one the most important aspects (other than asset allocation) of investing is ignored and not discussed in the general media. That topic is the fees we all pay to invest and you need to think of them as your worst enemy right now.[ad#tdg-embedded]
From the same book referenced above, there is an excellent graph that shows the impact of fees on an investor’s return. In the example, the growth of $10,000 over a 50 year period before costs was 8%. After costs (transaction fees, spreads, other commissions) the return drops to a whopping 5.5%. Doesn’t sound like much of a difference? Let’s look at it in terms of real dollars – at 8% the investor is left with is over $469,000. At 5.5% (the impact of fees) the investor is only left with $145,500. That is a difference of $323,500. I don’t know about you but to me that is a huge amount of money.
However, that is not the end of this depressing story. The real problem with fees is that just as compounded returns can help us earn more and more money, compounded fees can be just as dramatic. The longer you invest, the more fees you pay and each and every year you end up paying more and more money in fees. Over the same 50 year period as above, fees will consume approximately 70% of your potential returns!
With this information in mind, I am certainly going to continue to be more focused on cost than I have been in the past and in fact will step up my efforts to ensure my costs are low. Here are some of the things I will do in my personal portfolio.
1. Use Low Cost Index Funds for My Core Portfolio
I have stated this many times, and it is part of my investing code. For the core portion of my portfolio I use low cost index funds. That means that I am not using mutual funds with any sort of load or high MER. Through my research, I do not see a reason to pay more than 0.75% for any type of index funds. I use both iShares and Vanguard for the majority of my index funds.
2. Keep Individual Stock Transactions to No More than 1%
I do hold a very select number of individual dividend growth stocks. When I do buy or sell a security, I will ensure that the commissions charged by my broker account for no more than 1% of the cost of the investment. Let’s say I have $4.95 commissions to buy and sell stocks. That means that the minimum dollar amount I can use to buy a stock is approximately $500 ($4.59 divided by $500). This is a minimum amount – I try to keep the commissions as a percentage of my investment at a lower level than that. 0.50% is an even better number,
3. Make Investment Decisions with Taxes in Mind
All my investment decisions will be made to ensure I do not pay too much in taxes. Taxes are inevitable, however the way investors structure their portfolios can help to ensure we do not overpay them. In Canada, that means holding fixed income assets in an RRSP.
These three actions I take, and will take in my portfolio, are pretty simple when you look at them. However, the impact of these simple actions can be very powerful over the long-term as we have seen. My two focus areas are now on asset allocation AND investment fees.