My $9,000 Mistake

Mistakes...

With this, the first ever article on this site, I wanted to accomplish a few things.

  1. I wanted to take a case study from real life and break down the financial impact and what could have been done differently. I hope to tackle lots of case studies on this site because I think they’re way more relatable than just me blathering on about my opinions (don’t worry I’ll do plenty of that too) and they help readers find ways to optimize their own situations.
  2. I wanted to put my own history up as something to be mocked. I’m not perfect here by any means and I’m learning lessons as I go, just like everyone else. I want you to learn from my mistakes and my successes so that in your own life you have more of the latter and fewer of the former (wow that’s a confusing way of expressing that idea…). I have a father that worked in Financial Services and I got a degree in Finance and I STILL managed to screw up plenty of things in my financial life that I look back on now and shake my head. The lesson here is that no one should feel bad for not knowing all the ways to save and invest and do everything right. The past is the past, we just want to focus on doing things a little bit better every day.
  3. I wanted to come away with some concrete, actionable steps that anyone reading this can apply to their own life and end up better for it. After all, the whole reason this site even exists is to hopefully change some lives for the better.

So that said, let’s dive into it. This is the story of how one little decision cost me over $9,000 in under 4 years and closer to $400,000 over the course of a few decades (thanks to our friend Compound Interest).

I’ll get into all the fun spreadsheet tables below to show how I arrived at those numbers for anyone that wants to dig in, but you’re free to just ignore that section if math isn’t your thing. I’ll run through the specific issues that cost me all that money in a separate section (teaser: it’s fees, lots and lots of fees).

Story Time

I started working full time back in the halcyon days of 2007 before most people had ever heard of things like “subprime mortgages” or “bank bailouts” and the economy was all sunshine and puppy dog tails. Now, I knew I was a long way off from retirement, but I had been told that as a good little worker bee I should be putting aside some dollars in a 401k (we’ll ignore that one for now) and IRAs. So for a few years, I did that, adding a couple thousand dollars into Traditional and Roth IRAs. However, like a dummy, it never really occurred to me that this money should be working for me in the stock market. Bank interest rates were a little higher than they are today (not that that’s difficult…) and so I just left the money sitting in there earning a couple %. I think I figured that with such small $ amounts, it’s not like the returns really mattered much anyway…(Oh young Andy, you sweet, Summer child…)

By the time 2011 rolled around I was a little older, a little wiser, and it occurred to me: “Wow, the market sure is rebounding from that big old crash we had! I’d better actually invest my money and get in on that”. It probably helped that by this point interest rates had plummeted and leaving money in a bank account was not that far off from stuffing it into a mattress in terms of return on investment… So I called up dear old Well’s Fargo and got those IRA accounts set up as brokerage accounts (meaning the dollars could be invested in stocks or mutual funds) and asked whatever advisor they had available about getting my money invested. I’m pretty sure I mentioned that I had heard index funds were the way to go, but my new best friend and financial advisor assured me that he had a better option and I naively said “Okay, sure, let’s do that!” He set me up with the mutual fund: MBGWX, which had a fancy prospectus talking about it’s risk level and its allocations and all sorts of things that I sort of understood from school, but not really…

As a quick aside, it’s the norm in the financial services industry for advisors like mine to receive a commission when they get you to invest in funds that the mutual fund companies are promoting. It’s no coincidence that the the ones they want to promote are the ones that are most profitable to them (and not necessarily best for the customers) because they have high fees. So, it’s no surprise in hindsight that my advisor was pushing MBGWX, where he probably got a nice little kickback, versus an index fee where he may have gotten nothing. Now, I knew that there were fees involved in the mutual fund (and I’ll cover them in detail below), but I didn’t realize just how much they would matter…

{Dramatic Pause to Build Tension}

The Numbers

What I’m going to show in the following tables are all of the transactions that happened in the almost 4 years in my Traditional IRA and Roth IRA accounts with MBGWX and contrast them with the same transactions in an alternate reality where I had just put the money in Vanguard and invested in a total market index fund. In these examples, I would have started with VTSMX (minimum investment of $3,000) and then converted to VTSAX (minimum investment of $10,000) when I had enough in there. VTSAX is the same exact fund, just with lower fees.

Traditional IRA

What Actually Happened:

Traditional MBGWX

An Alternate Reality:

Traditional Vanguard

Roth IRA

What Actually Happened:

Roth MBGWX

An Alternate Reality:

Roth Vanguard

The Final Breakdown

IRA Comparison Table

As you can see, the difference in returns over just a short couple years is pretty incredible and then when you think about how those numbers could grow over the course of a career, it’s truly staggering. By the time I’m around regular retirement age, I will have lost more than six figures just from this one, seemingly innocuous decision.

So let’s look at the different areas that account for all of that lost money:

Bank Fees

These were the smallest of the expenses that ate into my gains, but they rankle me mainly because of how excessive and unnecessary they were. I paid $40 cash in the Traditional IRA, $40 cash in the Roth IRA, and another $35 deducted from the value of the Roth IRA investments. These were purely just a money grab from my bank and got charged because the total value of my investments was below $50k (which takes some time when the annual contribution limit is $5500 or less). This is a terrible way to encourage a long term relationship with a new investor and I’m still annoyed about it to this day.

On top of this, for having the audacity to close my accounts in February 2015 and move them to Vanguard, I was charged a $95 termination fee in each account which got deducted from the sale proceeds of MBGWX. As the kids say, Totally Lame. (*I have no idea what the kids say)

Finally, and I don’t actually know if this was the bank or the fund charging this or what, but if you run the numbers you’ll see that on every new purchase of MBGWX I got $5 less in share value than the amount of money I was putting in (example: $2000 contribution gave $1995 worth of shares). They were charging $5 for every transaction which, while not uncommon, is just another way they were sucking my money away like greedy, little money vampires.

Lego Dracula.jpg

Back-End Load Fees

Front-End and Back-End Loads are a tricky way that mutual fund companies are able to pocket more money from their Average Joe customers, often without us even realizing what’s going on. They’re a percentage of the total value of your investment that’s taken out as a fee, either when you buy (Front-End) or when you sell (Back-End).

Let me quote Investopedia here (emphasis mine):

Some argue a load is the cost investors incur for obtaining an investment intermediary’s expertise in selecting appropriate funds. It is a matter of record that load funds do not outperform no-load funds. Generally, the sales charge on a load mutual fund is waived if such a fund is included as an investment option in a retirement plan such as a 401(k).

What does that mean? You’re paying extra for expertise that doesn’t actually get you any better performance. To me, that sounds a lot like setting your money on fire… At least in that case you’d get the warmth from the fire though…

Now, while Front-End Loads seem like an overt and ridiculous cash grab to me, I can theoretically see some benefit to Back-End Loads (which is what MBGWX has). The reason is that their fee is set up to start at 4% and reduce down to 0% over the course of 6 years. This was explained to me as a good thing because it encourages the investor to hold onto the investment for a longer term (which you want to do in retirement accounts anyway) rather than buying and selling frequently, which also drives up costs for the mutual fund company.

So, I figured, no big deal; by the time I sell this fund, it will have been way past 6 years and I won’t pay any fee. What I did not realize (and no one was quick to educate me on…) is that this 6 year countdown is independent for each time you buy new shares, not for the account as a whole. So every time I made an annual contribution or reinvested dividends, those new shares started off at 4% with a new 6 year countdown on them. If I kept investing, I’d never actually reach 0% on this fee.

This is why, if you look at the tables above, there are no new contributions after 2012. I realized this was a bad deal and I started putting my new annual contributions in the following years with accounts I opened at Vanguard.

Investment Returns

Now at this point, some of the investment savvy readers may be saying, “Wait a minute here, Aardvark Guy, you’re comparing Apples to Oranges! These funds are nothing alike, you can’t expect them to behave the same way over a few short years! They got different returns because they’re invested in different things!” and I’d say, “You’re absolutely right, hypothetical, yelling person…”

(warning: this may get a little into the weeds, ignore as you please)

HOWEVER, I think this misses the point. For one, gains are the name of the game here and I don’t think it’s unreasonable in a strong bull market (like we saw during this period) to want a fund that either beats or comes close to the returns of the overall market, especially when you’re paying a premium for it.

Now, MBGWX has a good bit of bond exposure (somewhere around 20%) and that, by design, would get smaller returns in a bull market than a 100% stock fund so that it’ll be more stable in a down market; I realize this. But really, I think that’s the wrong approach for a young investor anyway. Retirement accounts like these shouldn’t see withdrawals for decades, so down markets would just represent a chance to buy stocks on sale. It would have been much better for me to be invested in 100% stocks and experience the much higher gains over decades.

Finally, even if the allocation of MBGWX happened to be excellent, much of the returns they experienced were gobbled up by the last, and by far the largest, expense…

Expense Ratio Fees

This is the one that really bit me and the one that is slowly siphoning off literally billions of dollars from retirement accounts around the globe every year. “Expense Ratio” doesn’t even sound like it’s something you’re paying, maybe it’s just another of the dozens of metrics about a fund that sound fancy and imply that “this investment stuff sure is complex” and “you really ought to pay an advisor to help you out” (PS- I think this is all bullshit, but it’s what the industry would like you to believe).

In reality, the expense ratio is very simple. It’s a percentage of the total value of your investment that is paid to the mutual fund company for things like their administrative bills, the management of the fund, and even advertising the fund (such as those commissions we talked about for advisors that are encouraged to sell it). It’s generally always higher for “actively managed” funds becuase you’re paying a manager to pick winning stocks and other investments; whereas index funds calculate their investments automatically and therefore don’t have the same kind of overhead costs.

For MBGWX, the expense ratio is currently at 1.8% and was about 1.92% when I invested. To the uninitiated (like my younger self) that may not even seem that bad. After all, it’s less than 1 out of 50 (Math!), a small fraction of my investment, and the expectation is that I’ll be making a great return- maybe upwards of 10% some years, so no biggie right? In reality, this is one of the highest expense ratios out there and at this point I’d even consider something like 0.8% to be way too expensive. Why? Because a broad index fund like VTSAX has a fee of 0.05% (now down to 0.04%). With some simple math (1.92/.05), we see that the fee on MBGWX was 38.4 times more expensive. That means 38 times more money out of my account every year, even if the investments LOST money. That’s the really painful part of the expense ratio, you’re paying no matter what happens. This also means that to get the same return (for me) as VTSAX, MBGWX would need to pick investments that earn nearly 2% more than the market overall. That’s a pretty big hurdle to beat year in and year out and is one reason why more than 80% of active fund managers fail to beat the corresponding index options (Source).

Long story long, when you look at the tables above and see just how significantly MBGWX fell short of a broad index fund, it’s due in large part to these fees that are taken out daily, before the share price is even calculated, and eat up a big portion of the gains I could have been earning.

Wrap Up

So, as we saw, in just under 4 years I lost out on more than $9,000 that would have cost me essentially zero work and zero time. I just needed to understand the magnitude of the impact that seemingly small fees can have over time. In this example, I actually didn’t do too badly because I learned after a couple of years that the back end fees would keep biting me and I started putting new money in Vanguard. A couple years after that, I learned that the expense ratio would keep biting me and I paid the price (in fees) to get my money out of that bad investment and move it over to Vanguard where it could grow faster. In the long term, I’ll be just fine and I learned lessons that will keep on giving. My hope is that you can learn these same lessons from my example, without having to pay the price yourself.

IRA Comparison Table

As one final illustration of the power of compounding and the value of avoiding fees early on, take a look at the “Value in 40 years” line of the Final Breakdown table (repeated above). I took the end value from each scenario and extended them out over 40 years (a normal working career). I gave them the same average 7% return during that time, but dropped MBGWX to 5% to account for what’s lost to fees. That initial $9k difference balloons to a whopping $388,000! I don’t know about you, but I think that’d make a pretty huge difference in the quality of someone’s retirement and I’d rather be able to leave that money to kids or a charity than have it eaten up by mutual fund companies and financial advisors. The final lesson here: Investing as much as you can early on and minimizing fees will create a vast difference in the wealth that you have just a few short decades later.

Further Reading

Jim Collins over at jlcollinsnh.com has a fantastic stock series where he covers the benefits of index investing and basically every topic I can think of about investing. It’s a fantastic resource and I strongly recommend taking a look.

If you’d rather get his great advice in book form, check out The Simple Path to Wealth where he takes the content explored in the stock series and organizes it into an incredibly helpful and educational book. “Life changing” is not an exaggeration in describing this content.

You can also check out either of these books by Jack Bogle, the founder of Vanguard and creator of the modern day Index Fund. Tons of great wisdom.

A note: Libraries are a great alternative to buying books; you get all the same knowledge and pay nothing for it!

Actionable Steps

  1. Check out the “Further Reading” options. This is an area where a few minutes of time spent now to educate yourself can be worth thousands of dollars later; beats what they pay you at your day job, I’m sure of it.
  2. Take a look at all of your investments and find out all of the areas where you’re paying fees and how much they are.
  3. Consider alternative investment options, such as the low-fee index funds or target date funds offered by Vanguard. I’ve heard Schwab and Fidelity also have some good choices, but I don’t have any personal experience with them.
  4. Don’t wait! Take steps now so you can reap the benefits of compound interest without all the fees. Future You will be glad you did!

 

Disclosure: I’m not paid by any of these companies, but I invest the majority of my money with Vanguard because they have the lowest fees around and great customer service. 

One Comment, RSS

  1. Kristine August 31, 2017 @ 5:33 pm

    I definitely agree that index funds are the way to go. At least you learned now rather than later!

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