Investing math is a funny thing.
Something might seem counterintuitive on the surface. But it can actually translate into some very impressive numbers.
For example, the power of compounding often works in investors’ favor. This happens when the interest and gains that accrue to an initial amount of money invested begins to also accrue interest and gains.
The power of compound interest — which Albert Einstein once called the "the greatest mathematical discovery of all time" — can turn a small monthly investment into very big money over time.
Unfortunately, the same concept of compounding can be applied in reverse order.
According to index-investing maven and Vanguard Funds founder John Bogle, what you want to avoid is something he calls the "tyranny of compound costs."
Yet what, exactly, is the tyranny of compound costs? And is it something you really need to worry about these days?
Bogle is well-known as a pioneer in the index-investing world. He says one of the important and often-overlooked aspects of investing is cost.
Cost, he argues, can eat away at your money in the same way that compound interest can allow your money to grow.
Moreover, paying high prices (high fees) also happens to be the primary reason why some people’s investment results are far worse than others’.
According to a MarketWatch article, paying too much for your investments can rob you of about two-thirds of your gains.
It sounds crazy until you recognize what happens when supposedly small fees are allowed to run on for decades — Bogle’s tyranny of compounding costs.
To illustrate this point, MarketWatch quoted directly from an interview with Bogle:
"Let’s assume the stock market gives a 7% return over 50 years. If you get to 7%, each $1 goes up to $30. If you get to 5% (that would be 7% less the industry’s typical 2% all-in costs), you get $10.
"So $10 versus $30. You put up 100% of the capital, you took 100% of the risk, and you got 33% of the return! As I say to people, if that strikes you as a good deal, by all means do it!"
When you look at it that way, it’s easy to see why owning high-fee mutual funds — or paying high-fee hedge fund management fees — is a surefire way to reduce your overall returns.
Fortunately, the world of investing has become a lot more diverse than the one John Bogle cut his teeth on when he founded the Vanguard Funds in 1974.
Today, the tyranny of compound costs has been largely alleviated by the evolution of the discount brokerage industry, online trading, the burgeoning Exchange-Traded Fund (ETF) industry and the ubiquity of free financial data websites.
Discount brokerages such as Scottrade, TD Ameritrade, Charles Schwab, Fidelity and E*Trade have made investing in the equity and bond markets far cheaper than ever before.
Then you have ability to make those transactions on your own via the Internet, which has helped keep commissions and trading fees lower — not only at discount brokerages, but also at the big firms such as Morgan Stanley and Goldman Sachs.
Then there’s the expansion of the ETF universe, which now has made low-cost index investing, as well as investing in myriad targeted sector funds, extremely cost-efficient — as well as simple to do.
Finally, researching and keeping track of your investments via free financial news websites such as MarketWatch, Yahoo! Finance, Google Finance and many others has helped many people reduce the costs and fees associated with having to employ a full-service brokerage firm.
Of course, these sites won’t help you determine which stocks or ETFs to buy.
For that you still need the experience and wisdom of proven professionals in the field, professionals such as the cadre of experts we feature in our newsletters here at Uncommon Wisdom Daily.
So yes, paying big fees can eat away at your overall portfolio performance. Fortunately, the current investment landscape is such that there is no reason to pay a lot for your investments.
Now, you just have to make sure you are allocating to the right stocks, ETF, options, etc., that can give you the best chance of achieving your investment objectives — and that’s where the team at Uncommon Wisdom Daily comes in.
And in today’s Afternoon Edition, I plan to show you how we did just that in 2016 … and how we’ll build upon a solid year all-around to go for even-bigger gains in 2017. Stay tuned!