Last Updated May 24, 2011 10:32 PM EDT
I remember a time when it was possible to actually see the pennies change on the gas pump, though now the dollar column moves painfully fast for eyes. I also remember back in 2009 that I was paying less than half of what we're paying now. Emotionally, I'm mentally stomping my feet and complaining about the unfairness of it all. Logically, I'm reminding myself that it's a market based economy. The average American will pay $3,000 a year in gasoline, driving 15,000 miles per year averaging 20 miles a gallon!
Why it hurts so much
Dan Ariely, author of The Upside of Irrationality, explains why I feel the pain so vividly.
Because it hurts so much, I'm beginning to change my behavior. I'm combining trips and even avoiding some altogether. Though I may have some irrationalities, traditional economics is changing my behavior. As price increases, demand for the product at that higher price decreases. In fact, Americans are now driving less.
Your portfolio expenses - a different pain-free model
Let's get off gas prices for a moment before we all hyperventilate, and examine an area where we might actually have some control in reducing costs.
My research shows that the average investor pays about 2.0 percent annually in fees, and another 1.5 percent in emotions, by chasing what's hot. Fees are a combination of stated and hidden fees. Examples of stated fees are the annual expenses of mutual funds noted in their expense ratio. I show this fee averages about 1.25 percent annually. Additionally, funds have an average of 0.75 percent annually in hidden costs such as trading costs, and soft costs such as research.
The average MoneyWatch reader has a net worth of $600 thousand. Let's say that $300 thousand is the average size of their portfolio. That would mean that the 2.0 percent amounts to about $6,000 in annual fees. This pinch is less painful than that at the pump because the financial services industry finds ways to deduct it in a manner that is very difficult to see. And if you can't see it, you're spared the emotional pain.
In addition to the fees the financial services industry charges, investors tack on a fee from their own emotions and predisposition toward performance chasing. Studies conducted on this very subject demonstrate that investors are genetically programmed to chase whatever is hot. As an example, the average advisor on the TD Ameritrade platform put their clients 74 percent in equities at the height of the market on October 9, 2007. Yet on March 9, 2009, when the market was in the basement, that allocation decreased to 49 percent. Though I estimate that our emotions cost us another 1.5 percent annually, some studies claim our emotions cost us far more.
Thus, the average investor pays an average of 3.5 percent annually. With a $300,000 portfolio, that amounts to $10,500 annually. Luckily, MoneyWatch readers tend to be more informed, and typically don't pay this full amount. I'll address this in a bit.
You'll note that the $10,500 average cost of expenses and emotions is over three times the amount we would pay for $4 gasoline. Even if we take into account my assumption that MoneyWatch readers are more financially savvy and pay less than most investors, it's pretty easy to see they could still save more than the price of gasoline.
If we adjust the annual fee amount of the average MoneyWatch reader to 2.0 percent, rather than 3.5 percent, then there is ample opportunity to save. Cutting that 1.5 percent amounts to saving $4,500 annually on a $300 thousand portfolio, and is equivalent to free gas for one and a half cars!
Unlike our good friends in the oil industry, the financial services industry charges the consumer in ways that are unlikely to change their behavior. The shell game they play with fees carefully minimizes the pain of paying. So to counter that false sense of security, try this . . . every time you fill up your tank, look at the digits on the gas pump moving at warp speed. Then craft a mental image that the rate you are paying is $12 per gallon, and let the realization sink in that that's how much you may be paying in unnecessary fees and emotional mistakes.
Remember that changing your investment behavior may save you more than you will ever pay in gasoline. And if that doesn't motivate you to change behavior, nothing will.
note: Gas Price Picture from NewsCopy.org
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