- January 26, 2018
- Posted by: fortunatetrader
- Category: Market
How to increase my rate of return avoiding the outrageous fees.
Welcome to the first article of a series of several about “How to increase my rate of return”.
They won’t follow a linear structure. Just take them as they come. 🙂
In this one I want to show you how absurd it can be paying someone that can lose your money.
Some of you have the luxury to invest in different forms of retirement accounts.
I won’t name them all today because you could be reading this article from anywhere in the world.
Maybe you don’t have one and you just rely on different forms of tax-free saving accounts that you consider your nest egg for the future.
Most of the time it’ll be the above case or someone will have suggested that you invest in a mutual fund.
What is a mutual fund?
A mutual fund is an investment vehicle that uses money from many investors to invest in diversified stocks, options, bonds, or other types of investment and assets.
Who can help me invest in a mutual fund?
Hedge fund management firms decide how to invest the money, and for this they charge a management fee to cover operating costs and a performance fee from the money in the fund.
So, fund managers are working for hedge fund management firms and charge me a fee to put my money into mutual funds. Got it?
If someone charges me a fee for just deciding where and how to invest my money is it something that I can actually do myself with just a little bit of knowledge?
Why wouldn’t I want to be THE fund manager for my own money?
Management fees can eat you alive.
We cover them in another article but for a rough idea, the fees can get salty.
*-Management fees of 0.5-3% of assets.
-Transaction costs when a manager sells or buys holdings
-Marketing and distribution expenses 0.75%
-Service fees 0.25%
-Account or so called maintenance fees
“Ok, I get it but if I don’t have to do anything and I can get a net annual return of 6-10%, well, I don’t mind paying someone 2-4-5% of fees, do I?”
I’m a lazy individual and if I can end up in a better position that I am right now, moneywise, I don’t mind paying a professional to help me achieve that.
The only thing though is that this “professional” is going to charge me ANYWAY.
“Woah Woah Woah, wait a minute I’m paying this guy without knowing if I’m gonna get my return?”
A fund manager runs and decides how to invest the money and for this he is paid a fee, which comes from the money of the fund itself.
A lot of mutual funds charge fees of up to 1.5 to 2%, regardless of the fund’s performance.
And no matter if they have generated more money or lost money during the year, they will still charge you fees, while index funds theoretically don’t charge very much in fees.
In fact, an astounding 96% of actively managed mutual funds fail to outperform market expectations over an extended period of time.
Warren Buffett issued a challenge to the hedge fund industry ten years ago. He bet one million dollars that they couldn’t put together a portfolio of *hedge funds that would outperform an S&P 500 Index fund (representing roughly the market) over a 10-year period. Protégé Partners LLC took the deal and selected five hedge funds while Buffet went with Vanguard Admiral Shares S&P 500 Index Fund.
CNBC reported in August 2017: “The hedge fund portfolio is up just 22 percent over nine years. That’s slightly better than 2.2 percent per year. How did the S&P Index fund do? Oh, just a smidgen better. It’s up 85.4 percent, or 7.1 percent per year on average.”
I invite you to read one of the articles on the topic linked at the bottom of this article.
Let’s use an example for an investment of $10 000.
You have been saving for the past 3 years and now it’s time to invest it in your future.
You gave the $10 000 to a professional that is going to invest it for you.
Conservatively, we’ll use a total fee of 3%.
So upfront the fund management firm is going to reduce the amount of capital that you are investing by $300.
So you don’t get $10 000 now to invest.
You are starting with $9 700.
Thanks a lot!
I won’t get into taxation and inflation but let’s assume that your money grew by 6% because your professional manager did a great job diversifying this into a fund for 100 businesses.
Your $10 000 after year one looks like this:
$10 000 – 3% fee = $9 700
$9 700 + 6% = $10 282
Every fund manager will tell you that you did a fantastic 6%, but pay attention.
You actually have done 2.82%.
Initial 10 000$ vs the 10 282$
And I’m not even talking about other fees, expenses or higher fees.
And yes, this guy did a great job finding you something that got 6% during the year.
“What about if they get 1% return or even worse, if they chose something that goes -5%. Do I still pay them?”
Well my friend… the sad answer is Yes.
Like discussed earlier, even if the fund is going down you have to pay the fees.
Using the same scenario after year 1 but now with a loss of 5%:
$10 000 – 3% fee = $9 700
$9 700 + -5% = $9 215
You actually have done -8.52%.
Initial 10 000$ vs the 9 215$
Thank you, brother!
The impact of the fees
I’m adjusting a simple and fascinating example that I have borrowed from one of Tony Robbins book: Money Master the Game: 7 Simple Steps to Financial Freedom.
Let’s say that three friends, aged 30, are investing $10 000 each in a mutual fund for 40 years. They all get the same return but unlikely get different annual fees.
Tom gets a growth rate of 7% and a total management fee of 3%.
Alex gets a growth rate of 7% and a total management fee of 2%.
Mat gets a growth rate of 7% and a total management fee of 1%.
Only a 1% here, a 1% there…
At the first view it seems like nothing but with a closer view you are able to appreciate your retirement from a totally different position. Will you feel at peace or will you pray holding on to government allowances/benefits/annuities?
“OK, MAG, but I’m not smart as they are so if I would have managed my own money I would have probably lost way more than that.”
You are right.
Maybe you would have.
But what they did is to put your $9 700 into 100 businesses.
They diversified it because if one company goes south the others can still perform well.
They call that diversifying your “risk”.
“If you are currently invested in mutual funds or are considering putting your money into one, always remember your fund manager just wants to keep your money.
Try telling them that you want to invest on your own and they’ll say good luck to beating the market. In fact, “nobody beats the market.” And if they’re not beating the market, then what are you using them for?
If you’re paying them to NOT beat the market, then you’re better off keeping that cash and investing it yourself.” – Phil Town
Did you know that you can manage your money doing this “diversifying” strategy and investing it through probably any well-known bank website platform now for far less fees than that?
Keep reading. I’ll show you.
– Make It Happen –
* “Hedge funds are managed much more aggressively than their mutual fund counterparts. They are able to take speculative positions in derivative securities such as options and have the ability to short sell stocks. This will typically increase the leverage – and thus the risk – of the fund.”