Wednesday, April 24, 2013

The Retirement Gamble

If you have a 401(k) or IRA or any investments at all, click here for a must-see video "The Retirement Gamble" from last night's FRONTLINE on PBS.  The moral of the story:  When it comes to investing, expenses are your enemy, and index funds are your friends.

During the video, Jack Bogle, the founder of Vanguard and the inventor of the first low-cost index mutual fund, stated that over a lifetime many investors keep roughly one third (1/3) of their investment gains while Wall Street takes two thirds (2/3).  As shocking as it may seem, I wanted to reiterate that Jack Bogle's figures are correct.

Take the following example that I calculated with my financial calculator.  Say you are 24 years old and change jobs.  You have $10,000 in your 401(k) plan that you roll over to an IRA at Vanguard and invest in low-cost index funds.  Over the next 60 years your mix of mutual funds average 7% annualized returns.  When you are 84 years old your account would be worth $579,464.

Instead, let's say you go to your local bank branch and give your money to their financial advisor.  This advisor charges you a standard 1% annual fee and he invests your money in mutual funds that have expenses of 1% (or more).  This is an extremely common scenario. Thus, you can expect to earn 5% on your money (instead of the 7% above) due to the higher expenses.  After 60 years when you are 84 years old your account would be worth just $186,792 for a whopping difference of $392,672.  

So Jack Bogle's figures are exactly correct.  186,792 / 579,464 = 32.2%

In a typical financial advisor scenario, you will give away 2/3 of your wealth to your financial advisor over the course of a lifetime.  

$10,000 invested at 7% for 60 years turns into $579,464
$10,000 invested at 5% for 60 years turns into $186,792

1 comment:

  1. I just watched the Frontline show on the frontline website. This should be required viewing for everyone. And of course the math is correct - even if if is hard to believe. That's why the industry gets away with charging such high fees, because nobody can imagine that a 2% fee could do so much damage.