How could a lifetime of investing lead to Wall Street keeping 80% of the returns, while the consumer/investor keeps only 20%? Quite easily, as investing and fee-fighting pioneer John Bogle taught us. I explain it in Chapter 5 of Gotcha Capitalism. Here’s the relevant excerpt. I present it again today to honor Bogle, a true consumer hero.
Sneaky fees are flat-out killing your retirement plans. They may very well force you to work an extra four or five years before retiring. They are stealing roughly one out of every three dollars you expect to have in your old age. The younger you start, the worse the sneaky-fee effect is: A twenty-year-old who invests today can find Wall Street has stolen 80 percent of his or her return when age eighty-five rolls around! We all know how retirement can affect your mental health, but imagine on top of that you only have a per cent of the money you were expecting instead of the full amount.
Perhaps you are wondering how I could claim that a tiny 2 percent fee could end up costing you years off your retirement.
But I’m not the one making that claim. The U.S. Labor Department is. And so is Congress’s investigating arm, the Government Accountability Office.
In a study conducted during 2006, Congress found that a 1 percent increase in fees works out to a 17 percent decrease in retirement funds after 20 years. Here’s the example it used: $20,000 parked in a 401(k) earning a reasonable return for 20 years would be worth $70,500 if mutual-fund fees were 0.5 percent. Increase those fees to 1.5, and the kitty sinks to $58,400.
As time goes by, the impact gets much worse. Using similar numbers, the Labor Department found that after 35 years, the same one- point difference in fees can shrink a $227,000 kitty all the way down to $163,000—nearly a 30 percent punishment. A difference like that can genuinely impact your quality of life at retirement—or simply force you to keep working. If you save a respectable $10,000 per year into your retirement, you’d have to work an extra five years to make up for the loss caused by that 1 percent fee difference.
Who gets hit the worst by these fees? Those who follow Wall Street’s advice and begin investing as soon as possible. Let’s go back to that precocious twenty-year-old we’ve already mentioned, who began investing even before she could drink
Taken cumulatively, a twenty-year-old who makes a one-time investment and then lives to the ripe old age of eighty-five will find that fully 80 percent of the money generated by that investment goes to Wall Street, with only 20 percent left to our judicious investor. John Bogle, founder of Vanguard, tells this tale by using simple numbers: $1,000, invested at age twenty, and never touched through age eighty-five, assuming an 8 percent return each year, nets the investor $160,682 after 65 years. But subtracting a 2.5 percent cost of investing each year, the return shrinks to $34,250, with Wall Street taking $126,432—that’s 79 percent to Wall Street, 21 percent to the investor.
Bogle calls this, fittingly, “The Tyranny of Compounding Costs.”
You can see a year-by-year breakdown of this on PBS’ Frontline website.