High fees can erode your savings

It’s a rule of thumb that the more something costs, the higher the quality of the item. This is not the case with investing, however. And it is costing people millions of lost dollars in retirement savings.

Fees and investing. The science of behavioral economics can help us understand what’s going on. There’s a term called “quality theory” that says people often assume a higher price indicates better quality and a higher long-term return on investment.

You can see this theory playing out with index funds. These funds are all virtually similar in terms of how they work and how they are constructed, yet their fees vary widely, depending on the asset manager.

Morningstar offers the following example:

study on index fund fees showed that there are large levels of fee variation among S&P 500 index funds that are virtually identical in most relevant characteristics. RYSPX and SWPPX, for instance, are two S&P 500 index funds with a holding similarity score of 99.99 percent.

Over the past 20 years, based on current fees, if you had invested $10,000 in RSPYX you would have paid $4,475.32 in total fees. On the other hand, if you had invested $10,000 in SWPPX over the same period, you would have paid $101.30 in total fees. This massive difference cannot be attributed to differing underlying characteristics, because the two funds share almost identical portfolios.

Compare funds. The other problem with comparing fees is that fee amounts on funds appear to be small, with percentages ranging from 0.50% to 1.0% and 2.0%. But these seemingly small differences can make a huge impact on your savings over time.

Make sure you look at the fees you are paying on the funds you are investing in, and consider making a change if you are paying too much.

 

* All figures in 2012 dollars. Workers are assumed to begin saving at age 25 and retire at age 67. Example reflects median salary of $30,502 when worker starts saving at age 25. Example provided by CAP.

 

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