While there's wisdom in the saying, "Don't sweat the small stuff," it's less true when it comes to your hard earned money. Three may seem like a little number, until you're talking about 3% losses, or 3% percent in investment management fees and expenses.
Here's how small can be huge.
"How big is 3%? Over time, it's really big," says Mitch Tuchman, managing director of investment advisory service Rebalance IRA.
He offers up the example of Joe and Mary. Say they both start with $100,000 in their IRAs and make their maximum yearly contributions of $5,000-$6,000, and both lower their risk over time. Mary gets 3% more per year than Joe. If Mary starts at 35 years old, she retires at 65 with $740,000 more than Joe and if she starts at 45 years old, she retires at 65 with $252,065 more than Joe.
"A 3% gap, year over year, becomes a very large hole," says Tuchman.
That "small" percentage is especially enormous for large portfolios, "It can mean a state university or a new car is slipping through the cracks each and every year," says Donald Cummings, Jr., managing partner of Blue Haven Capital.
Even with small losses, it can take several years of good returns to just "break even" and for those heading toward the retirement finish line, "you'll still lose the gains from those years. Many seniors don't take this into account as they're planning for retirement," points out Dan White, a certified financial planner with Dan White and Associates.
Are you paying attention to fees?
Do you know how much you're paying in fees and expenses for your investments? For any individual with a relationship size of over $100,000 with a money manager, they should be paying less than 1.5% when management fees, internal fund or ETF fees and even 12b1 fees are all added up together, says Cummings. For someone with $500,000 or more, that figure drops below 1,25%, and for those with a million-plus, the figure should definitely be less than 1%.
While those who depend on commissions will divert attention away from costs, there is no shortage of studies and experts who say portfolio expenses have the singular most important impact on a portfolio.
Simply put, "Fees are the biggest investment killer out there," says Matt Becker, founder of momanddadmoney.com.
One is a big number
Becker says even a 1% difference is huge. If you invest $10,000 for 30 years and earn an 8% return, you end up with just over $100,000. Take out 1% in fees per year and you're left with a 7% return and only $76,000 after that same 30 years, he explains.
"That's almost a quarter of your money gone just because of a silly little 1% extra paid for your investments. Cutting costs is one of the surest ways to increase investment returns and give you a better chance of reaching your goals."
You have to understand how the financial services industry makes money. "If not, you'll pay exorbitant fees," says Tuchman.
What can you do?
"I always recommend people look for a Vanguard or Schwab type relationship if they are doing things on their own," says Cummings. If you're hiring someone to do the work for you, hire someone who does not make money on commissions, he says. "It seems fairly obvious that if someone is paid through commissions, that person will guide clients into commission-based products. Some of those products carry commissions as high as 6%."
Truth is, all investments have risk. Even leaving your money in cash is not immune from losses. The dollar's decline over the past 30 years has been far greater than most people realize, says John Lau, president and CEO of LFS Asset Management. It has lost almost half its value against other major currencies since 1985 and is down 33% in the past 11 years alone. "So it is not whether you will lose on any particular investment, but what risk management strategy do you use to cut the losses short while letting the winners run?" His answer, "diversification, position sizing and stop losses."
What you don't want to do is to try and time the market. If you took the performance of the S&P 500 from January 1, 1990 through December 31,2012, you would have a return of 8.55% per year or $10,000 growing to $66,009. If you would missed the five best days during this time because of market timing, your performance would drop to 6.63% or your $10,000 growing to $43,790, says Michael Gauthierm, CEO of Strategic Income Group. If you were to lose 3% over this time period due to unnecessary fees, for example, you would drop to 5.55% and your $10,000 only grows to $34,636. "This is a loss of over $31,000. It is crucial to understand where your returns are coming from. What is your gross return, and what is your net return?"
Every situation is different
Just to muddle the water, there can be times when paying 3% in fees for example, might be worth it. "Cost is only an issue in the absence of value," says Sean McComber, a certified financial planner. He says he has a client, a married couple where the husband is 11 years older than the wife. He is a military veteran with a life-only pension.
From an actuarial point of view, there is a high likelihood that he will die before her, and since the pension makes up nearly 50% of their current fixed retirement income, this could have very serious negative consequences for her cash flow over her remaining years. They have a variable deferred annuity with a living benefits rider that will help to grow the income at an accelerated and predictable manner so that when he does die before her, the annuity lifetime income can be activated to replace the lost pension income. The fee for this annuity and rider is in the neighborhood of 2.5%, but, says McComber, "They gladly pay the cost because of the value placed on the income growth and guarantees."