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Are you losing money?

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You pay on average 1-2% in fees to someone else just so that they can manage your money. This means that even if they are great at managing your money, you are going to lose between a third to a half of your potential earnings over a 30 year timeframe. Of course the research shows that you are likely paying a crappy manager to manage your money in the first place considering the larger money managers significantly underperform independants. Which means that you are likely able to match or beat their performance with minimal effort.

Why do I say that you are going to lose 30-50% of your money? It is pretty simple compounding interest math. As your investment grows, the schmuck you are paying to manage your money earns more money. The tough part is that they are not trying to earn you more money because of this – they are trying to match the market returns. This means that if you match the market returns through something like an ETF you can obtain the same returns without paying all of those fees to your “money manager“. I know – I don’t usually talk about ETFs, I recommend in my ESPP posts that individuals can do better than just investing in ETFs, I will use ETFs for this example as they take much less thought to implement and are commonly used in these comparisons. Of course if you want to beat the market, I recommend you start by reading the series on Investing Lessons from Venture Capitalists.

As an example, let us assume that the market returns 6% annually. So for every $10,000 you have invested, you will earn $600 every year (this is a fairly normal assumption on the return of the S&P – bonds of course are another story). If you are paying someone else to manage your money (@2% for example) you would pay them $212 for that 6% return on $10k. That seems pretty silly to pay someone 1/3 of your earnings for matching the market return.

Let’s walk through this really quickly… Compound returns are equated as FV=PV(1+r)^n… all that is saying is that the future value of your money is equal to the present value multiplied by the rate of return over a time period. The financial genius that money managers use is a much more complicated equation an equation so we’ll use a table to explain it…

Compounding Value Compounding Fees Account Balance
 $ 10,000.00  $         –
Year 1  $ 10,600.00  $ (212.00)  $ 10,388.00
Year 2  $ 11,236.00  $ (436.72)  $ 10,799.28
Year 3  $ 11,910.16  $ (674.92)  $ 11,235.24
Year 4  $ 12,624.77  $ (927.42)  $ 11,697.35
Year 5  $ 13,382.26  $ (1,195.06)  $ 12,187.19
Year 6  $ 14,185.19  $ (1,478.77)  $ 12,706.42
Year 7  $ 15,036.30  $ (1,779.49)  $ 13,256.81
Year 8  $ 15,938.48  $ (2,098.26)  $ 13,840.22
Year 9  $ 16,894.79  $ (2,436.16)  $ 14,458.63
Year 10  $ 17,908.48  $ (2,794.33)  $ 15,114.15
Year 11  $ 18,982.99  $ (3,173.99)  $ 15,809.00
Year 12  $ 20,121.96  $ (3,576.43)  $ 16,545.54
Year 13  $ 21,329.28  $ (4,003.01)  $ 17,326.27
Year 14  $ 22,609.04  $ (4,455.19)  $ 18,153.85
Year 15  $ 23,965.58  $ (4,934.51)  $ 19,031.08
Year 16  $ 25,403.52  $ (5,442.58)  $ 19,960.94
Year 17  $ 26,927.73  $ (5,981.13)  $ 20,946.60
Year 18  $ 28,543.39  $ (6,552.00)  $ 21,991.39
Year 19  $ 30,256.00  $ (7,157.12)  $ 23,098.88
Year 20  $ 32,071.35  $ (7,798.55)  $ 24,272.81
Year 21  $ 33,995.64  $ (8,478.46)  $ 25,517.18
Year 22  $ 36,035.37  $ (9,199.17)  $ 26,836.21
Year 23  $ 38,197.50  $ (9,963.12)  $ 28,234.38
Year 24  $ 40,489.35  $ (10,772.90)  $ 29,716.44
Year 25  $ 42,918.71  $ (11,631.28)  $ 31,287.43
Year 26  $ 45,493.83  $ (12,541.15)  $ 32,952.68
Year 27  $ 48,223.46  $ (13,505.62)  $ 34,717.84
Year 28  $ 51,116.87  $ (14,527.96)  $ 36,588.91
Year 29  $ 54,183.88  $ (15,611.64)  $ 38,572.24
Year 30  $ 57,434.91  $ (16,760.34)  $ 40,674.58

 

That is a lot of money you’ll lose – over $16k… Roughly 30% of your potential earnings. Would you like to have an additional 30% in your account? I know I would!! Most of the research out there talks about the affect of compounding fees inside of mutual funds, etc. The same applies to paying a manager who is charging you an assets under management fee. About that famous compound interest quote – Einstein did not actually pen any quote about compound interest. Which is good, you need to think for yourself sometimes and realize that compound interest is great and compound fees are a cancer.