Sunday, December 11, 2011

Are you putting your investment advisor's kids through college?

The next time you walk into your local bank and their hot shot salesman investment advisor asks you to pay him 1% per year to place your money in his impressive list of mutual funds he has hand picked, all with stellar track records - simply turn on your heel and walk out.

Here's why.  Over a long period of time, say 20 years, the stock market will likely average about 8% annual return (2-3% from dividends + 5-6% in capital gains).  If you pay a salesman investment advisor 1% to put your money in mutual funds with expense ratios of 1% you will only achieve a 6% annualized long-term return.  In other words, you will give up 25% of your possible investment returns!

But, with these high fees, the power of compounding is working against you.  So it is actually worse than 25%!  Let me show you how.

If you invest $100,000 at 6%, after 20 years you might have $320,000 - or a gain of $220,000.  Sounds good right?  But, if you invest $100,000 at 8%, after 20 years you might have $466,000 - or a gain of $366,000.

You could have gains of $366,000 if you bought index funds, but since you paid that salesman investment advisor 1% to put you in mutual funds with 1% expense ratios, you only earned $220,000. That is a difference of $146,000 over 20 years.  In other words, you probably put your bank's investment advisor's daughter through college - instead of your own!

To think about it another way, you could have increased your investment returns by +66% if you bought index funds rather than listening to your bank's salesman investment advisor! (146/220 = 66%).

If you are fortunate enough to have $500,000 to invest, just multiply the above numbers by 5.  After 20 years you would amass $2.3 million with an 8% return, but just $1.6 million at 6% annual return. That's right, you would be out a whopping $730,000 over 20 years (146 x 5 = 730).  You likely paid for your investment advisors house - instead of your own!

I think these numbers speak, no SHOUT - very loudly why I believe everyone should learn do it yourself investing using Vanguard index mutual funds.  Even if you think you might make a mistake or two doing it yourself, there is no question you will come out ahead.  One of the worst things you can do with your money is give it to your local bank investment advisor and pay him 1% per year to put you in mutual funds with 1% expense ratios.

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