Save Your Way to a New BMW 7 Series Sedan, or 80 3G iPads
The season is upon us. Over the next few weeks, millions of Americans will spend countless amounts of time and energy shopping. But most of us aren't content with merely filling out our shopping list -- we need to find a deal. So we scour the Black Friday ads, appraise the "door buster" deals, and time our trips to maximize coupons that last for mere hours.
But what's puzzling is that many shoppers who set their alarms for 3:00 am in order to load up on $5 DVDs end up spendings tens -- if not hundreds -- of thousands of dollars more for their investments than they need to.
Perhaps the problem is the way these choices are marketed. So today I'll try to present it in terms that the majority of Black Friday shoppers will understand.
The average equity mutual fund carries an annual expense ratio of about 1.3 percent. On the other hand, numerous low cost index funds can be found with expense ratios of less than 0.1 percent. An annual savings of 1.2 percent or so may not sound like much when your early morning shopping trip netted a GPS for 50 percent off, but that small number can produce staggering results.
Earn Yourself a Top-of-the-Line BMW
For example, assume that we have two investors. One invests $10,000 in an equity fund charging 1.3 percent in expenses; the second invests $10,000 in an index fund charging 0.1 percent.
If the stock market provides an average annual return of 8 percent, the first investor's net return will be 6.7 percent, and the second investor's net return will be 7.9 percent. After 40 years, the first investor's account will have grown to just under $134,000; the second investors's account will be worth $209,000. Simply by minimizing their investment expenses, the second investor will have accumulated some $75,000 more than the first investor -- enough to allow them to drive off into retirement in a brand new BMW 7 series sedan.
Two New iPads a Year for 40 Years
If that's not enough motivation, consider another example. Let's assume that the two investors above determine that they need to accumulate $1 million 40 years from now. To do so, the high cost investor -- earning 6.7 percent annually -- will have to save $5,410 per year. The lost cost investor, earning a 7.9 percent annual return, will need to save $3,963 each year. The $1,447 annual savings is nearly enough to allow the low cost investor to purchase a two 32-gigabyte 3G iPads each and every year.Regardless of how you elect to spend the extra money you have in your pocket as a result of minimizing your investment expenses, any grizzled Black Friday veteran will tell you that it's a wonderful problem to have.
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