Markets

Why We Don't Even Notice Investment Fees (Unlike High Gas Prices)

By Allan Roth

Updated on: July 6, 2009 / 6:21 PM EDT / MoneyWatch

The price of gasoline is skyrocketing again and, as I filled the tank of my family car yesterday, I started feeling the familiar pain of watching the digits spin at Warp Five and the corresponding toll it was taking on my wallet. It got me to thinking of the possibility of gasoline hitting a new record of, say, $4.60 a gallon. We could easily be paying $3,286 annually for fuel.

Paying that much for gas would be dÃ©jÃ vu all over again from last summer, when Americans found that they needed to start changing their travel plans to accommodate the price increase. Those lazy summer days, since gas was too expensive to go anywhere, had us dreaming of a more fuel-efficient car, like maybe one that ran on water. Just grab the hose from the front yard and fill'er up. How great would that be?

While there isn't such an engine that I know of, there is something even better. If you have a $200,000 portfolio with typical total fees of two percent, you could actually save more than owning a water-fueled car by lowering costs to 0.25 percent.

Don't believe it? Well, let's take a look at how much you could save with each:

Car That Runs on Water: 15,000 miles Ã· 21 miles/gallon @ $4.60/gallon = $3,286

Low-Cost Mutual Fund: 1.75% savings on $200,000 = $3,500

Eliminating the painful stops at the gas pump would save us $3,286 annually if gas reached $4.60 a gallon, and $1,857 annually at today's price of about $2.60 a gallon. Yet by cutting our fees on a $200,000 portfolio, investors would save a full $3,500 annually.

Pure economics dictates that the more money we lose, the worse off we are. Not exactly quantum physics. Therefore, economic theory would predict that we'd change our investing habits before we'd change our driving habits. But we don't.

And the reason we don't is that our actions are not typically ruled by the law of economics -- or even logic, for that matter. Any investor with two brain cells to rub together knows intellectually that they're likely paying high costs for their portfolios, but prefers to ignore them rather than take the effort to figure out just how high they are. On the other hand, unless you pump gas with a blindfold, it's pretty much impossible to ignore how much it costs to fill up the gas tank.

My Advice
I wish the disclosure in the investment industry was as transparent as the auto industry. Wouldn't this disclosure on our 401(k) plan be nice?

Unfortunately, the most that can be done is to try to hack through the dense thicket of data to find this information. If you have a planner, ask them in writing to estimate the total fees you are paying. This would include fees:

Based on a percentage of assets.
Based on commissions.
Within the funds that are part of the portfolio.
Hidden within a portfolio or fund such as commissions, spreads between the bid and the ask price when funds turnover stocks, and other fees known as market impact costs.

If you manage the portfolio yourself, go to Morningstar and look up the expense ratio, which will give you the disclosed part of your fund's fees. Then look up the fund's annual turnover on Morningstar's site, divide by 100 and add the two together. For example a fund with a 1.25% expense ratio and a 75% turnover would have an estimated 2.0% annual total fee (1.25% + 75%/100).

Of course the easiest way to rein in your fees is to make sure you have a few ultra low cost broad index funds such as a total US, international, and bond index fund such as those of a simple second grader portfolio. It won't completely take the sting out of stopping at the pumps, but at least it may sting a little less to know you are saving more on investments than you are spending on gasoline.