Do we live in the golden age of investing?Moronic question, right? Of course we don’t.
The S&P 500 sits at about the same level it did five years ago. Bond interest rates have never been lower, and the Fed says it’s planning to keep them that way through mid-2015.
Turn on any financial channel and you’ll find as many gloomy predictions as you care to sit through: debt-fuelled implosion in Europe, the next flash crash, the shrinking dollar, a stagnant labour market, Great Depression 2.0 (or is it 3.0 by now?).
Perhaps I’m just hard headed, but my money is still invested and my mattress is filled with memory foam, not cash. It’s been a while, I know, but does anyone else remember the 20th century? The century in which every conceivable horrible human catastrophe happened, but investors, on average, did great?
Well, the landscape for individual investors is different now than it was for most of the last century: it’s unequivocally better.
It’s all about the fees
Last year I had the privilege of interviewing Burton Malkiel, author of the classic book A Random Walk Down Wall Street.
He reminisced, not too fondly, about the investing landscape of the 1970s, when the first edition of his book came out.
“The typical mutual fund at the time had a 7% load fee,” said Malkiel. “So a $2000 investment might mean $140 in essentially a commission.”
In addition to the 7% front load, that mutual fund probably also charged about 2% in annual expenses. Keep that in mind as we look at a price war that broke out last month between two mutual fund giants.
In September, Schwab announced price cuts on most of its exchange-traded funds (ETFs). An ETF, for our purposes, is basically equivalent to a mutual fund.
Schwab’s flagship stock fund, the US Broad Market ETF (SCHB), now charges 0.04% a year and their Intermediate Investment Grade Bond ETF (SCHZ) will cost you 0.05%. If you also buy and sell the ETFs through Schwab, there are no trading fees whatsoever.
(Disclosure: I’m a Schwab account holder but don’t own these ETFs.)
Schwab’s price-chopping executives had a particular competitor in mind: Vanguard. This month, Vanguard struck back by announcing changes to the indexes underlying some of their most popular funds.
I realise this is about as exciting as the political scenes in the Star Wars prequels, but there is an upshot: the new indexes are cheaper to licence, which will mean lower costs in the future. Vanguard’s Total Stock Market ETF (VTI) currently charges 0.06%.
(Disclosure: Vanguard is a Mint.com Ways to Invest partner, and I own the mutual fund version of Total Stock Market.)
So, let’s compare the fees paid on a $10,000 investment by a 1970s mutual fund investor versus someone investing in that dirt-cheap Schwab stock fund today:
That’s a 99.6% reduction in fees.
But wait, maybe you got more for your money back then. In a sense, you did: you got a friendly brokerage representative who would always try to sell you new stuff.
If you invested enough, maybe you’d get to join him for golf, unaware that your money paid for his clubs.
The actual mutual fund, however, was much worse: less diversified and more likely to underperform in the market.
Savings at work
That’s great for your personal investment account or your IRA, but many of us do most of our investing at work through a 401(k) or similar workplace retirement plan. Here, the facts are less golden but things are looking up.
A 401(k) plan has recordkeeping and other expenses that individual accounts don’t. Except at the largest companies, 401(k)s will likely always charge at least a little more than individual accounts.
Many 401(k)s, however, charge a whole lot more. As of 2011, the median annual fee paid by participants in 401(k) plans was 0.78%. That sounds small, but:
- The fee compounds over time, taking more and more of your savings as you get closer to retirement.
- That’s just the average fee; some plans are much, much worse, charging well over 2%.
- That average fee is over 19 times the price of that cheap Schwab ETF, and nearly 28 times the price of the nation’s best 401(k), the Federal government’s Thrift Savings Plan (TSP).
But the trend in 401(k) fees is pretty good and getting better. Average fees dropped by over 9% between 2009 and 2011. And this summer, new 401(k) fee disclosure rules went into effect.
You may have already received a statement from your 401(k) showing exactly what you pay in fees and expenses; if not, you should get it by early November.
In theory, at least, employees should be marching into the benefits office waving their statement and complaining about high fees.
Don’t people already know what they pay for their 401(k)? Not at all. When the AARP surveyed 401(k) investors last year, 71% of respondents believed incorrectly that they pay no fees.
The bottom line
Why all this harping on fees and expenses and so little attention to the performance of the markets themselves? Because you can’t control, predict, or successfully time the market, and markets are never safe and boring. You can only control:
- How much risk you take, by deciding how much to invest in stocks and how much in bonds or cash.
- How diversified you are, by choosing broad-market mutual funds or ETFs.
- How much you pay in fees and expenses for your investments.
What if your 401(k) is one of the sucky ones, with a base of expensive funds and administrative expenses piled on like rancid frosting? Fight back.
Plenty of people who would argue over a $25 parking ticket wouldn’t think of spending 10 minutes to write a letter to their benefits office asking for cheaper investment options in their 401(k), even though the latter could save them thousands.
Here’s a guide that includes a sample letter.
The best investors are unrepentant cheapskates. For them—for us—the golden age is now.