High investment fees will ruin your retirement

High investment fees hurt. We should all try to minimize them. Conventional wisdom, right? In one way you would think so with the rise of firms like Vanguard, discount brokers, ETFs, etc… On the other hand, there has been the massive rise of hedge funds, derivatives, and other esoteric products that have high fees. Given how much fees can impact returns I think its important to go back and get reminded just how much so.

I ran across an article in the British newspaper The Telegraph about the impact of fees that blew me away. The article in particular talks about the impact of hedge fund fees on investment results. Here are the money paragraphs so to speak;

Taking typical hedge fund fees as an example – but widening his attack to performance fees charged by rising numbers of unit trusts and open-ended investment companies (OEICs) – Mr Smith said: “”As you are aware, Warren Buffett has produced a stellar investment performance over the past 45 years, compounding returns at 20.46 per cent per annum. If you had invested $1,000 in the shares of Berkshire Hathaway when Buffett began running it in 1965, by the end of 2009 your investment would have been worth $4.8m.

“However, if instead of running Berkshire Hathaway as a company in which he co-invests with you, Buffett had set it up as a hedge fund and charged 2 per cent of the value of the funds as an annual fee plus 20 per cent of any gains, of that $4.8m, $4.4m would belong to him as manager and only $400,000 would belong to you, the investor. And this is the result you would get if your hedge fund manager had equaled Warren Buffett’s performance. Believe me, he or she won’t.

Read it again. You would have 1/12th of the money had Berkshire been set up as a hedgefund! I think that would have made a slight difference in your retirement lifestyle. Simply staggering. And yet people plow money into hedge funds without considering these effects.

As a reminder its not just the direct impact of those annual fees on that year’s account balance, its the compounded return those fees would have generated had they remained in your account (opportunity cost gone wild). I put together a simple table to show the impact of a range of fees on a investment account over different periods of time.

The table shows the impact of a range of fees, from 0% to 2%, on a $100K account assuming a 10% return over a 30yr and 50yr time period. I chose the 30yr period because that is a common retirement planning period and the 50yr one because fees also impact the wealth accumulation phase of your life. Over a 30yr period, a 1% annual fee will reduce an account from $1.7M to $1.3M, a 24% reduction. The same fee level over a 50yr time period would reduce the investment value by 40%.

Hedge funds have an additional layer of fees, performance fees, that make matters much worse as the Telegraph article points out.

Remember those fees. They’re real killers.