Learning how to invest money can seem daunting at first. But if you focus on what really matters and dispense with what doesn’t, you’ll be well on your way to building a more financially secure future.
Want to make more money over time in your investments? Of course, we all do! That’s why seeking out low investment fees should be top of mind for you.
It may sound unbelievable, but a difference of as little as less than 1% in fees can add up to tens of thousands of dollars when compounded over the years!
Make low investments fees the cornerstone of your education when learning how to invest money
A study from BuyUpside.com shows that just a difference of 1% in annual fees can mean an $80,000 difference in retirement. Here’s how the math works:
Let’s say you invest $100,000 today with a 5% annual return and you pay 1% in annual fees. In 30 years, you would have $319,694.
Now let’s say you invest $100,000 today with a 5% annual return and you pay 2% in annual fees. In 30 years, you would have $235,755.
Paying what seems to be a measly 1% more in fees — 2% instead of 1% — eats an $80,000 hole in your retirement plan! What seems inconsequential in the here-and-now actually has a huge effect on your future wealth.
The math in this chart is really compelling, courtesy of BuyUpside.com and USA Today:
What are reasonably low investment fees to pay?
Recent research by the Center for Financial Research & Analysis, an independent investment research firm, shows that a couple of mainstream banks that also offer investments and other big financial firms can fee you to death on simple index funds.
All investments shown below represent certain share classes of S&P 500 index funds that have an expense ratio of more than 1%. There may be cheaper share classes of each fund available, but we’ve focused on those with the highest expenses.
|BlackRock iShares S&P 500 Index Fund (BSPZX)||1.2%|
|Invesco S&P 500 Index (SPICX)||1.29%|
|JPMorgan Equity Index (OEICX)||1.05%|
|Rydex S&P 500 (RYSYX)||2.33%|
|Wells Fargo Index (WFINX)||1.2%|
Keep in mind that as S&P index funds, all of these selections hold the same individual stocks of the Top 500 biggest U.S. companies.
That’s important to understand because it means these kinds of index funds require little-to-no hands-on management on the firm’s part; they’re simply tracking the components of a well-known index.
So why are investors paying so much for them?
Compare the expense ratios you see above to this offering from discount brokerage house Fidelity Investments:
|Fidelity ZERO Large Cap Index Fund (FNILX)||0.00%|
That’s right — Fidelity has no fees whatsoever associated with this investment! And it gives you exposure to 500 of the biggest companies in U.S. capitalism, just like the indexes from JPMorgan and Wells Fargo.
Why pay when you could be getting virtually the same investment product for free?!
Fortunately, it’s not just Fidelity that makes it free or cheap to invest. You can get 500 Index Fund Admiral Shares (VFIAX) from Fidelity’s arch-rival Vanguard with an expense ratio of just 0.04% — that’s 96% lower than the average expense ratio of funds with similar holdings.
In layman’s terms, an expense ratio of 0.04% means just four pennies out of every $100 you invest goes toward expenses. The rest goes to work building your financial future.
By the numbers: Putting two index funds to the test
Barron’s ran some numbers to see the impact of what just $10,000 invested would look like over 10 years in the low-cost Vanguard offering vs. the high-cost BlackRock offering.
The numbers are telling…
|Initial investment||Investment vehicle||Expense ratio||How much $$ you’d have after 10 years|
Here are some other basics to keep in mind as you start learning how to invest money…
Start saving early
A 15-year-old who saves $2,000 each summer for 10 years and lets the money grow in a retirement account until 70 can easily amass $1 million or more. That’s without ever contributing another penny after 25!
These numbers assume an 8% average gain annually, which sounds like a lot until you consider it’s below the average return on the stock market since 1926 — even accounting for all the ups and downs of the 1930s Great Depression, the Great Recession of last decade and all the bear markets of the modern era.
Of course, inflation will greatly eat away at the purchasing power of $1 million when a 15-year-old eventually retires, but the point is that it can be easy to build some level of comfort and security into later life if you’ll just start saving early!
Most people don’t start thinking about saving until they hit 40. Begin early and it can make a big difference down the road.
Invest equal amounts of money on a set schedule
By making regular contributions each month or each pay period in equal amounts, you are doing what’s called dollar cost averaging.
That’s just a fancy way of saying that you’re pacing your investing against the market. With the same dollars each month, you’re buying more shares when prices are low and fewer when they’re high.
Over time, putting money in this way — rather than all at once in big lump sums — reduces the possibility of panic in you and keeps you steady as you go. And being able to comfortably stay in the game makes you more money over the long haul.
Diversify your portfolio
Spreading your money out among both domestic and international investments is one of the safest ways to invest. That’s why mutual and index funds are preferable over individual stocks. Pick four or five mutual funds for your portfolio with at least one being an international fund.
When you’re younger, you want more stocks and fewer bonds in your portfolio so your money has the optimal time to grow. As you age, you can do the reverse with more bonds and fewer stocks.
Go with a discount broker!
A couple of years ago, a financial columnist named Kathy Kristof reported on findings that the typical investor who makes an annual $4,000 contribution into an IRA can lose 54% in fees alone each year.
There are three fees most commonly associated with commissioned investments: The ‘load,’ which is the commission itself; 12b-1 fees, a dubious marketing charge that pays for advertising to attract more money to the fund; and an annual management fee, which you always want to be lower than 0.5%.
The takeaway here is simple: Don’t buy your investments through full-commission brokerage houses or an insurance agent.
Instead, buy your investments commission-free (aka with ‘no load’) through discount brokers that hold down the other expenses too. Vanguard, Fidelity and T. Rowe Price all do a great job of this, among others.
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