003 - Let's Talk About Fees

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Publish Date Dec. 23, 2016
Podcast URL http://www.choosefi.com/003
Tags 401k blogger brk_meetup indexfunds stocks

Transcript

Time Speaker Text Tags
0 - 13 Jonathan Mendonsa So today we're in the studio and we are going to be specifically talking about a topic that is very important to most of the financially independent retired early community and that is the importance of avoiding excessive fees.
13 - 19 Brad Barrett It is such a fundamental topic and yeah we wanted to make one of our very first podcast about this.
19 - 29 Jonathan Mendonsa So we're going to do one of the things that you're supposed to avoid at all costs on a podcast and that is talk about numbers. And on this particular show we're going to violate that rule a lot.
29 - 30 Brad Barrett Hopefully this works out. We'll see.
30 - 36 Jonathan Mendonsa I think it will work out well we're going to cross some bridges here. Brad You just want to kick this thing off and let us know your epiphiny.
36 - 51 Brad Barrett Yeah for sure. So pretty much like everybody else. I'm an investing moron. I had no idea what I was doing for years and years and years. Sign up for your 401k. You get this list of 20 or 30 mutual funds and you have no idea what you're looking at right. What do you do when you look at a chunk.
401k
51 - 64 Jonathan Mendonsa You know it really is difficult to dig down in there and figure out exactly what you're looking at and even to know how you're supposed to look at it. So I think a lot of us just kind of ask our peers or maybe we do a google about the top five funds something like that.
64 - 72 Brad Barrett Yeah that's the two things I think most people do are ask the guy in the cubicle next to them and look at the morning star rating.
72 - 75 Jonathan Mendonsa The guy that's going to have to work for the next 60 years.
75 - 142 Brad Barrett Right And how many stars did Morningstar give it for its performance over the last year. That's not what you do. Thankfully. Thankfully I've come to a conclusion here and on the backs of many many brilliant people this is nothing that I did on my own but once I've kind of realized this that these are the most important thing and that index funds and low cost ETF are the way to go. It's almost like you want to stand up on the top of a mountain and scream at everyone like you not invest in high cost mutual funds do not invest in actively managed funds or God forbid like a hedge fund or something where they're giving away 2 percent and 20 percent of the profits. I mean these will destroy your long term wealth absolutely destroy it. My realization here came about after reading a couple of different items and the first was Jim Collins. He writes over and JL Collins Nh dot.com he has a brilliant series is called the stock series I think. I'm not sure at last count is probably up to about 30 different blog posts in that particular series and he's actually turned it into a published book called The simple path to wealth.
blogger, indexfunds, stocks
142 - 146 Jonathan Mendonsa And rightly so that is a phenomenal phenomenal series.
146 - 241 Brad Barrett It's brilliant and Jim has become a good friend of mine over the last couple of years and I consider him a friend and a mentor and I tell him every time. I mean we're really reading those articles changed my entire life. It changed the entire course of my investing life. I mean you don't get that every day. You know I mean what what if you read on the internet lately and that has changed your life. It's pretty rare. And so then I moved on to a book called The Little Book of Common Sense Investing by John Bogle the founder of vanguard. Right. I mean it's it's really and when you put together these different sources of information you realize it's like an aha moment you know that there is no way that my feeble little brain that's full of emotion and fear is ever going to outperform the market. It's simply not you hear that. I'm not sure if this is a true thing or not but I heard it six months ago that Fidelity put together a study of which of their investors have performed the best over the last X number of years and it was the joke or realistic answer. But the joke is the people who are dead it's the people who didn't trade. They didn't try to outsmart anything didn't get fearful when everyone was selling or get exuberant when everyone's buying and the stock market's going up. It's the people that just kept the course and you know in this case because they were dead. Right. But but keeping the course not letting your emotions get into it. So I mean that is essential in and of itself. You are not going to find some brilliant financial advisor that your brother in law uses or the guy at the Edward Jones office right down the block from you.
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241 - 244 Jonathan Mendonsa And how many times do you hear that. I have a guy right.
244 - 253 Brad Barrett I have a guy like you know he's some brilliant person I mean the likelihood of you finding that brilliant financial advisor is as close to zero as possible.
253 - 274 Jonathan Mendonsa And the fact of the matter is if he were that guy he probably wouldn't want to deal with you because he probably has multimillion dollar clients. Now whether or not you should have the guy or not. That's just a reality. The guy probably doesn't need you or have time for you. So you probably didn't find the guy but even if you did you probably do but that's the case here that you probably shouldn't try.
274 - 324 Brad Barrett Yeah without a doubt and just looking at the performance of actively managed mutual funds so let's you know kind of pivotal that I sort of focus on it in one episode so actively managed mutual funds. I mean there is really no correlation in the results of these things there are very few that outperform over years and decades. Right. I mean do you know of any Jonathan. I mean maybe the fidelity contra fund. I think for a while outperformed. But they all eventually revert to the mean and that's if you're lucky. You know the if you're very lucky the actively managed mutual fund that you're going to select is going to perform as well as the market because again you know you're getting all these fees just built into it trading fees taxes you know all this stuff just further cuts down on your return and the return of that mutual fund.
324 - 333 Jonathan Mendonsa And so what are we talking about are we talking about it's costing you $20 $50. You know can we attach some numbers to what these fees are actually going to be costing us.
333 - 386 Brad Barrett That's a great segue we before we went live here I went up pulling up the Dave Ramsey investment calculator which Jonathan just turn me on here will have a link to this and the show notes it's probably the best investment calculator either of us have ever seen. It's really very intuitive and easy to use and just kind of for shits and giggles I threw in some some numbers here just to kind of prove the point. So basically what we did was we initially threw in that we were starting with $100000. That's a lot of money for many people. But just bear with us here. We figured over a long term over a 40 year period stock market is going to return let's say 8 percent. It might be plus or minus but that's that's what at least reasonable based on history. In this hypothetical we're not putting any additional money into it it's just that 100 K on day zero and we're going to let it ride for 40 years.
ramsey, stocks
386 - 388 Jonathan Mendonsa OK. Let it ride brother.
388 - 407 Brad Barrett Yeah yeah yeah. So in this scenario we said we didn't hire a financial adviser and we didn't get sucked into an actively managed mutual fund. We just invested all 100000 in the VTSAX which is vanguards total stock market index fund that has an expense ratio of point 0 5 percent.
indexfunds
407 - 411 Jonathan Mendonsa Now just for just for our audience is that that's a good expense ratio.
411 - 432 Brad Barrett That is absolutely fantastic. Minuscule I mean many actively managed funds. I mean maybe in this day and age you can it's hard to find ones over 1 percent but you can certainly for many many years they've been 1 percent. Even an international fund just see one point three and upwards of that you know many of them will have points 6 .7. That doesn't sound like a lot of money right Jonathan.
432 - 437 Jonathan Mendonsa Well no no it doesn't. I mean I mean it's better than the interest rate my bank is giving right now. But yeah it doesn't sound like a lot.
437 - 466 Brad Barrett Right. So it sounds miniscule. So many people intuitively think how can six tenths of a percent and point 0 5 like you're getting in the TSA X or 1 percent and point 0 5. How can that really make a difference for me long term. It's just such a tiny amount. It's less than 1 percent of my of my assets right. And you know what we're going to try to show here is what a difference it makes. So the first scenario we ran like I said is just putting in a VTSX so it reduces our return from 8 percent to seven point nine five.
466 - 475 Jonathan Mendonsa OK so a hundred grand. After you pay your expenses you're making an annual annual rate return of seven point nine five percent. And we're letting it ride for 40 years.
475 - 484 Brad Barrett So it compounds for 40 years what we've got. It's 2.1 $3 million. Wow. Yeah. So two million one hundred and 32000.
484 - 487 Jonathan Mendonsa So basically right now you're saying a hundred grand guarantees you're a millionaire.
487 - 529 Brad Barrett Yes multi multi multimillionaire just for putting it away doing nothing with it. Waking up in 40 years looking at your statement and meeting a cardiologist essentially. OK. As John Bogle would say that's one of my favorite quotes of his. So what we did was scenario two is we invested the same hundred grand in VTSAX and for whatever reason we decided to hire an investment adviser. OK. They usually charge 1 percent of assets under management. So that further reduces your fee by one return by 1 percent. So in this scenario we have the 8 percent gross return. We reduced it by the point 0 5 from the mutual fund and 1 percent in the investment advisor.
529 - 538 Jonathan Mendonsa So it sounds like so now instead. So now basically you have 100 grand now your annual rate of return after you pay your fees is six point ninety five percent correct.
538 - 545 Brad Barrett So we hit hit calculate and it comes out to one point four million dollars one million 460.
545 - 552 Jonathan Mendonsa Do you realize the implications of that that one change I just did the math in my calculator you just lost 630 grand.
552 - 564 Brad Barrett Now is that amazing or what. Just by having that financial advisor who honestly is probably just a salesman or just some moron off the street. I mean the likelihood of your investment advisor being Warren Buffett is zero.
564 - 575 Jonathan Mendonsa So if you had 100 grand and you were about to invest it for 40 years and you just heard this and changed your mind on how you do it feel free to send me a thank you card with a $10 gift card to panera bread because I would say do 630 grand.
575 - 580 Brad Barrett Just from that one change. All right. Your investment advisor he might be a nice guy. He might be able to help.
580 - 582 Jonathan Mendonsa Is he worth six hundred thirty grand.
582 - 582 Brad Barrett Not A chance.
582 - 583 Jonathan Mendonsa No way.
583 - 623 Brad Barrett Not a chance in hell. So then the third scenario was doing everything wrong. OK. We started with that 100 grand and we had the 1 percent investment advisor and we had a 1 percent actively managed fund because in all likelihood if you're going to some brilliant investment advisor he's not going to put you in the VTSX because he can't justify his fee then. Yeah. So he has to justify his brilliance by putting you in some fantastic mutual fund that he found and those mutual funds have a significant expense ratio. So just for this back of the envelope thing we're assuming a 1 percent expense ratio on that mutual fund so that reduces our annual rate of return from 8 percent down to 6 percent.
623 - 635 Jonathan Mendonsa So now in this third scenario that's really really bad. scenario and Now you've got 100 grand and now because of all the fees that you're paying out to the various parties you're only making a 6 percent rate of return and you're still letting it ride for 40 years.
635 - 642 Brad Barrett So we hit calculate and the return the total worth after 40 years is one million twenty eight thousand dollars.
642 - 660 Jonathan Mendonsa Oh wow. You realize that that just cost you over a million dollars. That one choice you went to two Web sites or you went to you want one choice lead you to your adviser. The other choice lead you to VTSAX the difference between those two that seemingly innocuous choice was 1.1 million dollars.
660 - 665 Brad Barrett Or more than 50 percent of your potential return if you just put it in VTSAX.
665 - 667 Jonathan Mendonsa That is crazy. Yeah that's crazy.
667 - 673 Brad Barrett It's just because that little innocuous Oh it's just 1 percent of my assets it's nothing. It's something.
673 - 681 Jonathan Mendonsa Do you think that that will be something that somebody should tell you before you get off into the world and you're just making your own choices. That seems like that would be a useful piece of information to know.
681 - 725 Brad Barrett Yup without a doubt. And honestly also a big thing and this is psychological and I know I can speak from experience when I had no idea what I was doing. I was constantly thinking about am I in the right mutual fund. Am I doing this right. Should I rebalance between my international and my fidelity contra fun and some other mid-cap fund and all this other nonsense. I had no idea what I was doing but that was just what everybody was saying. So it sounded logical. Now I put every single dollar into VTSAX and now people have good faith people of intelligence certainly in the Bhogle heads community and such. People will argue of should I put some in bonds should I put some in international and that's fine. Again people of good faith can have that argument and I'm not saying my way is right.
725 - 753 Jonathan Mendonsa You know and I think you can take this and you can there's some actionable tips you can come out of. And we're not necessarily telling you that you have to do the VTSAX although we love that fund. What we're saying is that fees matter and if you didn't understand why they matter going into this podcast they matter because it's the difference of millions of dollars and whose Do you want that whose pocket you want millions million dollars to be in because it could have been in yours or it can be in the guy that already has the power boat. I mean just just think about it for a second.
753 - 815 Brad Barrett Yeah that's a brilliant point. So that's the ancillary benefit again is is the psychological aspect of this. I sleep well at night. I don't think about this. I like to paraphrase that quote from Bhogle. It's if you put in regular investments and don't try to time the market don't try to be brilliant just buy a little piece of every publicly traded United States company. That's what the total stock market index fund is. It's you own a tiny little piece of every publicly traded company in America. Thirty two hundred or thereabouts companies and you're just you're betting on America like Warren Buffett always says you know he is bullish on America. And 40 years from now you're going to wake up and you are going to have more money than you could possibly imagine and you never had to time and you never have to think about it. And like we talked about these fees the likelihood of success this is one of those odd things in life where normally having knowledge and having information puts you ahead of the game you're in it almost with investing it almost hinders you in most cases.
indexfunds, stocks
815 - 822 Jonathan Mendonsa As long as the one piece of information is the as the tiny little bit that we're giving you then yeah absolutely.
822 - 836 Brad Barrett Absolutely. But right these superbly sophisticated hedge fund guys or whatever like most of them don't really know their ass from their elbows frankly. And over the long run I am confident in the United States stock market and I'm confident in the fees the fees.
stocks
836 - 852 Jonathan Mendonsa You know you say the United States stock market but a lot of those companies that you're investing in are in fact global powers. So if you invest in every major company inside the United States you are by definition also investing in global companies all across the world.
852 - 915 Brad Barrett Without a doubt. And just to kind of further this point here is looking at Warren Buffett's annual shareholder letter to Berkshire Hathaway one of the most interesting quotes that I've ever heard that kind of helped corroborate this. If Warren Buffett agrees with this and he's the most brilliant investor of all time essentially. He laid out a retirement plan that he's leaving behind for the trusts for his wife and quote My advice to the trustee could not be more simple put 10 percent of the cash in short term government bonds and 90 percent in a very low cost S&P 500 index fund. I suggest vanguards. That's Warren Buffett saying what he's going to do with the billions of dollars that he's leaving. He's going to put it 90 percent of it in a low cost Vanguard index fund. Now he chooses the S&P 500. I personally choose the total stock mark index fund at the end of the day because it's cap weighted. They marry each other almost identically but in this case you're getting an additional 27 hundred companies but you're getting a tiny tiny little piece of it but the end of the day the advice is the same. Go with the market and go with low fees.
brk_meetup, indexfunds
915 - 933 Jonathan Mendonsa So that's been your actionable tip of the day. If you want more relevant actionable content please check out our Web site and follow us on Facebook Twitter Pinterest and your other social media Web sites. We appreciate you listening and we look forward to having you next time. As we continue to go down the road less traveled.
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