Please, please, please teach this concept to your students. The concept of compound interest makes the “greatest hits” list for most personal finance curricula. What doesn’t make the list is the impact of “compounding fees” which has a dramatic impact on what is left over after a lifetime of investing.

Courtesy of NY Times and Vanguard, we now have a handy chart showing exactly how much of an investor’s returns get eaten up by those ever so subtle fees that have a dramatic impact on what’s left at the end:

First, some quick orientation is in order. The chart was created with these assumptions:

• $40,000 year starting salary with an annual raise of 1%.
• Conservative investing return of 4% (historical equity returns are closer to 7-9%)
• Savings rate of 6% of their salary
• 30 year savings period

The individual bars in the chart indicate the account balances (in thousands of dollars), after 30 years, based on the assumptions above. Why do the bar heights differ? Yes, you guessed it, it’s the fees! An index fund may carry fees of 0.25% of assets (or lower) while actively managed funds have fees close to 1% on average. One flaw that I see with this analysis is that it assumes the same 4% return for each of the funds before fees. Therefore, this chart wildly understates the impact of fees as the lowest fee funds typically are the best performing funds. Yes, investing is one of those rare instances where the best products are the cheapest!

Questions for students:

• Compare the investor in the fund with 0.25% fees to the investor in the high cost fund with 2.5% fees. How much less does the investor in the high cost fund have after 30 years?
• Calculate how much of the gains are lost for each of the higher cost funds (compare each of the funds with the 0.25% fund). Figure out the dollars that are lost through fees as well as the percentage of the gains that are lost.
  • For example, for the fund with the 1.0% fee, an investor loses $18,000 when compared to the 0.25% fund. In terms of the percentage lost, you can calculate that by dividing that $18,000 by $151,000 which is 12%.
• How does an investor find out the fees in their investments?

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Check out this resource from the NGPF Interactive Library: Why Investing Fees Matter!

About the Author

Tim Ranzetta

Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.

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