Investing Strategies
Why do we want to invest our money in the Stock Market (Wall Street). The answer is simple: over a long period of time the stock market will appreciate more than just about any other type of investment you can think of. Generally speaking the stock market includes stocks (equities), bonds (fixed income), commodities (gold, pork bellies, currencies), real estate (mortgages, REITs) and so much more. If it sounds complicated it’s because it is! I will try to help you through all of that.
Let’s say you don’t know much about the stock market or have well founded fears about losing your money. What’s the alternative? Your main options are savings accounts, certificates of deposit (CDs) or government savings bonds. With those, if you’re fortunate, you’ll get a return of about 1%. Unfortunately for you the current rate of inflation is about 2%. Putting your money in those instruments is a losing proposition. You really have little choice but to invest in the stock market.
Mutual Funds
Who hasn’t invested in mutual funds? I think just about everyone I know had some money in Fidelity’s Magellan Fund at one point; I certainly did. Common wisdom says that if you have less than a million dollars you should buy mutual funds. They’re a cheap and easy way to get a professionally managed, diversified portfolio. The mutual fund industry has done a lot to encourage just that kind of thinking. As always, the devil is in the details.
If you invest in mutual funds you probably know about ‘A’ and ‘C’ shares. With ‘A’ shares you pay a percentage of the amount you invest right up front in the form of a fee (typically between 3% and 5%). ‘C’ shares have no up front fee. What you may not know is that there is an ongoing expense that you pay for this fund. You pay a higher expense for ‘C’ shares but there is still a substantial fee for ‘A’ shares. This expense never goes away; you pay it year after year after year. There is another even lesser known fee called the 12B-1. This fee is usually a much smaller amount but you will have to pay it year after year as well. I like to call small, hidden charges like that, “graft and corruption”.
Ongoing fees for ‘A’ shares are typically in the 1% range. For ‘C’ shares they are typically in the 1.75% range. 12B-1 fees are less than 0.25%. Note: For many 401K accounts and high net worth individuals there are often (but not always) ‘K’ or ‘X’ class shares that have much lower expenses.
I have created a simple model (click here) that shows if you invested $10,000 for 20 years and accounted for all of the fees and expenses you would have the following…
- C-Shares: $25,834.32 (an increase of 258%)
- A-Shares: $28,886.10 (an increase of 289%)
- No Expenses: $38,696.84(an increase of 387%)
Note: When considering performance of any investment you should always look at the percentages. Using dollars amounts for comparison is often misleading.
Because we took 4% right off of the top of the A shares the principle amount we started with was smaller but because the expenses were also smaller the amount grew much faster. This illustration shows that A shares will outperform C shares if the investment is kept for at least five years. Even after 20 years the difference between the two is significant but not huge. Those expenses really weigh on the portfolio’s performance.
The illustration with no expenses outperformed the better performing A shares by almost 100% – a very substantial margin. Yeah, but is it possible to pay nothing for your investments? Of course not, but I can show you a way to pay only 0.03% (that’s not three cents on the dollar, that’s three hundredths of a cent on the dollar). That’s about as close to nothing as you’re going to get.
Next up, let’s talk about financial advisory services.
(Remember: I am not a professional financial planner. This article is meant only for illustrative purposes. You should check with your own financial advisor before embarking on any retirement plan.)