Killer Fees

When I was in grad school, a very silly woman lived in my dorm.  About halfway through the second semester, she decided to fall in love with Gerard Depardieu.  She had never seen one of his movies.  Her knowledge of him came from a single article she read that waxed on about him.  But that was enough for her.  Everything from that point on was Gerard Depardieu this, and Gerard Depardieu that.

(In part, I think she just liked saying his name.  And let's be honest, who doesn't?  It's totally fun.  Try it with me.  Gerard Depardieu, Gerard Depardieu, Gerard Depardieu.  See?)
 

She droned on and on, every meal, talking about him to anyone who would listen.  Also, anyone who wouldn't.   Gerard Depardieu is the greatest actor in the modern era.  Charming.  Charismatic.  Elegant.  Suave.  So handsome.  Beautiful, really.  And because he is French, he is much more sophisticated than American actors, so American audiences can't even appreciate him.

After two full weeks of torturing us dorm residents with her ode to Gerard Depardieu, she finally went to see one of his movies.  And then, came back.

She never spoke of him again.

In case you didn't know, this is Gerard Depardieu:

He's basically an ogre.

Okay, so what's the point of all this, right?  Three of the four statements below are Gerard Depardieu quotes pulled from the internet.  The fourth is the theme of this post.  Can you find the theme?

(Hint: The answer isn't a staple of ogre behavior.)

When it comes to investing, there is a LOT of hype out there.  Magazines have covers with big ol' banners like "Get Rich Quick," or "15 Hot Stocks," or "Best Moves NOW."

TV financial evangelists actually yell their advice at you - what to buy, what to sell, and why the market will plummet or skyrocket.

And then there are the local salesmen.  Stock brokers, financial services providers.  Nicely dressed folks in dark wood offices who assure you that they will take better care of your money than you could ever possibly hope to do without them.  And then go on to very professionally fleece you of your money.

Ignore the hype.  Know the reality.

I was helping an elderly neighbor of mine who had her finances tied up with the local office of a big name investment firm.  The firm was making a zillion stock trades each year.  Her year end paper statement, this is not a joke, was consistently over four inches thick.  I spoke to the firm's associate vice president, on my friend's behalf, as to why they did so much trading.

"Well, we have a large research staff that helps construct a portfolio tuned to her specific situation.  This is the service that we provide."

"But it's creating an accounting nightmare.  Not to mention a sore back.  Plus, all of this trading isn't working.  You consistently miss her benchmark."

"That's not true.  We beat benchmark by 1% a year."

"Actually, you missed benchmark by 1% a year."

"No, we beat it."

"Really?  I would like to see the documentation.  Can you send that to me?"

His boss, who was on the phone with us, jumped in and said they were really busy and it would take a lot of work and several days to pull together.  I said I was in no hurry and would wait patiently - I know how difficult it is to push a button.  (Okay, I didn't really say that last part, but that's what I wish I said.)  Three weeks later, still no documentation.  But when I called to follow up, they finally admitted they missed benchmark by 1%.

"C'mon, Deadwood, get a life!  You're just on one of your silly rants.  Exceed benchmark by a point, miss benchmark by a point, what's the big deal?"

A two point swing is huge when compounded over years.  And guess what this firm was charging my friend for services rendered?  Two points.

Here is the reality of what a two point fee means for an investor.

Let's say you have $100K invested in a stock portfolio with a compounded annual growth rate (CAGR) of 10% a year.  After twenty years, your total return is $573K.  Huge, right?  Except, you don't actually get all that because your money manager takes 2% of your nest egg each year for services rendered.  So you net an 8% CAGR or $366K.  The difference is $207K.  In other words, the fees cost you a third of your potential profits.  That's the big deal.

It's worse than that.  You probably don't have your whole portfolio in stocks.  You probably have some in bonds, some in cash.  So instead of earning 10%, maybe you only earn 8%.  Which means 6% after brokerage fees.  So really, the fees cost you 40% of your potential profits.

It's worse than that.  There's inflation.  If you back out inflation of say, 3% a year, you are  earning more like 5% in real dollars.  3% after fees.  So really, the fees cost you over half of your potential real dollar profits.

Half the profits!  It's your money; you take all the financial risk.  But they cost you half of your profits.  And in all likelihood, give you nothing of value in return.

"My friend isn't satisfied with your services.  She would like to close her account.  The fees aren't worth it."

"Well, we might have been a little behind in performance, but we offer her a lot of other services for our fees."

"Like what?"

"For instance, we call her once a year to see how she's doing." 

"(Wait...did he just say that?)  Okay, well...I can call her."

Albert Einstein is supposed to have once said:

“Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it.”

Yeah, I'm pretty sure he didn't really say this, but it's a great quote anyway.  Because it's true.  Ignore all the hype from financial firms who use your hopes and fears against you.  The reality is that their fees are outrageous and stealing years off your retirement.

(Hey, you know what investment doesn't cost you 2% a year?  Index funds.  You can get them with expenses as little as 0.05% a year.  Did I ever mention I like index funds?)

Beware the well dressed ogre.

Avoid large fees.

Disclaimer: There is nothing wrong with being an ogre.  Some of our most beloved Hollywood stars are ogres.  Like Shrek, here. 

2014.09.18 Update: Gerard no longer drinks 5 - 6 bottles of wine a day.  Thank goodness!