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You guys never cease to amaze me.

Was I a little rough? Yes. Did I bash the mutual fund industry for picking our pockets? Sure. Did I expect some hate mail? Of course.

Feeling a little lost?
Don't worry -- here's a quick summary. A while back, I proposed an experiment. It was essentially bogus mutual fund I concocted out of just four stocks, each bought in January 1991 and sold in January 2000.

For my bogus portfolio, I chose these four stocks, but any number of former highfliers could have done the trick:

  1. Amgen (Nasdaq: AMGN  )
  2. Genentech
  3. Charles Schwab (Nasdaq: SCHW  )
  4. Ericsson (Nasdaq: ERIC  )

The idea was to show how a modest $10,000 investment could have ballooned to nearly $300,000 in 10 short years. But that wasn't the amazing part. For more details, check out this column: "Don't Invest Another Penny." But come back, because this is where it gets good.

You see, there was a catch. In those 10 short years, you'd have paid your mutual fund manager nearly $20,000 in fees and surrendered nearly $50,000 in lost profits (money not earned on those fees). So instead of $300,000, you'd be sitting on a lot less.

So, you hate me, right?
Of course you do, but I thought you'd take the fund company’s side. I thought you'd point out that nobody could pick just those stocks, much less time the market so perfectly.

In other words, I thought you'd say that the $70,000 blood money in my example was a gross exaggeration. Just wait until you hear what you really said.

You’ve got it all wrong!
Or so you told me. Apparently, you're fine with me comparing the fund industry to an IRS on steroids. You took me to task for understating the case -- for underestimating the real cost to you as an investor.

And you're right. John Bogle -- the founder of Vanguard Funds -- makes the case bluntly in his book The Battle for the Soul of Capitalism. Bogle shows that you don't need blowout returns (like in my superstock '90s example) to make the case against mutual funds ... you need time. Here's why.

Beware the "tyranny of compounding"
As it turns out, financial "intermediation" costs would have eaten up just 23% of your total returns ($70,000 out of $300,000) in my hypothetical example. That sounded like a lot to me, but apparently not to Bogle -- and to some of you, either. In fact, for most of us, it will be worse.

For one thing, you won't be making 2,900% every 10 years. That's because for every 10-bagger like Symantec (Nasdaq: SYMC  ) your fund manager digs up, he'll bite on a Krispy Kreme (NYSE: KKD  ) or Sprint Nextel (NYSE: S  ) , or some other over-hyped story stock. But mostly, he'll keep you bouncing between JPMorgan Chase (NYSE: JPM  ) and the other financials, and the rest of the most widely held stocks.

And even when your manager does catch lightning, he'll probably buy and sell too often, and at the wrong times. That's one reason Bogle thinks you'll earn less than "average" -- 8.5% per year by his estimate. Plus, you won't invest for 10 years, but more likely 25, 30, or even 45 years or more. Well, brace yourself, because this thing really gets ugly.

That'll be 80% off the top, sir
According to Bogle, if you invest for 45 years at his expected market return of 8.5% per year, these dastardly "intermediation" costs can steal up to 80% of your rightful profits. You read that right. Not a mere 23% like in my hypothetical fund, but up to 80%.

For one thing, Bogle uses a more aggressive 2.5% for intermediation costs. That's because he goes beyond reported "management fees" and includes taxes, transactions, and timing costs. And given that Bogle founded Vanguard, the most trusted mutual fund company in the world, I'm inclined to believe him.

More importantly, Bogle realizes that the more realistic your returns, the more deadly that 2.5% becomes, especially when compounded over the years. In other words, costs kill when your portfolio keeps doubling every six months, but when it's doubling every 10 years or so -- costs kill you dead!

What you can do about it
Frankly, I don't share Bogle's lukewarm outlook for stocks. I think we'll do better from here, even after the recent bounce off the bottom. But if we make three times as much as Bogle expects, we'll fork over well more than $100,000 in intermediation costs every 20 years.

If you resent that, there's a solution a lot of folks are considering: Start managing some of your own investments. You don’t have to jump in all at once, and you don't have to dump your funds right away. But you can see how important it is that you give it some thought, right?

Of course, you will need a few great stocks to get started -- and maybe a little support. Here's something else to consider: Sign up for a free trial of Motley Fool Stock Advisor. Every month, you get useful investment advice plus the two top recommendations straight from Motley Fool co-founders David and Tom Gardner. It's free for 30 days, there's no pressure to buy anything, and if you do decide to join after your trial, it sure as heck won't cost you $100,000.

These are interesting times to be an investor, especially if you're going it alone. If you ever considered subscribing to an investment newsletter -- and wondered what all the fuss is about – this free trial offer may be the time to find out. To learn more, click here.

This article was originally published Sept. 29, 2006. It has been updated.

Paul Elliott doesn't own shares of any stock mentioned. Schwab is a Stock Advisor pick. Sprint Nextel is an Inside Value pick. The Fool has a disclosure policy.

Read/Post Comments (6) | Recommend This Article (8)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 27, 2009, at 11:31 AM, Aryabod wrote:

    On the matter of Sprint Nextel I beg to differ with you. Every public company is run by a unique sort of mgmt. that can make and break the company. The direction a company goes is directly proportional to the actions and remedies made by that mgmt. Contrary to popular belief it was not the merger of Sprint and Nextel that was disastrous but rather the team that executed the merger. Had a different team approached this merger the results could have been very different.

    Sprint's mgmt team under the auspices of Dan Hesse has done a decent job of cleaning house, which was absolutely necessary after taking the helm from the company's prior CEO in 2008. Over 40% of its unnecessary work force was truncated, SG&A costs were drastically cut back and efficiencies were put in place.

    Once the unnecessary bleeding was halted mgmt. put their focus back into growth. In the Q4 they purchased VM & iPCS which accomplished two things, it enhanced their Pre Paid subscribers by over 5.2 million with the VM purchase and avoided a costly lawsuit with iPCS which hamstrung Sprint in the States that were in question.

    Now Sprint is leaner than ever since its merger with Nextel. It is the Vanguard in the Clearwire syndication with a 57% stake in the company. It is joined by the likes of Google, Intel, Time Warner and Comcast in launching their 4G Wimax platform. By the end of Nov. 2009 Sprint/Clearwire had launched their Wimax in at least 33 cities in the US. They ensconced enough funding to complete another 50 cities in 2010, which should include NYC, San Fransisco, D.C., Boston, Houston and Southern California. In the Q4 they also introduced their most impressive line up of phones, which included the Palm Pre, Pixi, BB Tour, HTC Touch Pro & Hero and their Samsung Moment. They also introduced very competitive monthly plans, such as the Unlimited 'Everything Mobile,' for $69/m, which is half of what ATT and Verizon are charging their customers. All in all they finished the Q3 with close to $6 billion in cash, YTD Q3 FCF of $2.1 billion while launching their 4G platform through Clearwire.

    AT the beginning of Q1 2010 Sprint is well positioned to challenge its peers. It can now earnestly claim to have the fastest network in the nation. Its line up of phones will even get more impressive when they add the new Wimax enabled phones slated to be disclosed at the CES 2010 on Jan 6. They have Plans that are half the monthly cost of their competitors and they have drastically cut their cost structure, making them even more competitive.

    Sprint today is almost priced for bankruptcy when they are not even close to this. They have enough funds to meet their creditors all the way through 2011 and the company is still FCF positive. Assuming its FCF remained steady for the remaining five years the company could be completely debt free. However we all know that the market is far from being static and a company needs to be forward looking. Sprint by focussing on its next generation 4G platform is just doing that. They will have their platform up and running two years ahead of their peers. This is at a time when most of the growth in ARPU will be coming from Data.

  • Report this Comment On January 02, 2010, at 2:56 PM, cmm3 wrote:

    Ericsson is severely undervalued. See the full report here:

  • Report this Comment On January 08, 2010, at 3:58 PM, NASDAQCZAR wrote:

    krispy kreme donuts kkd is a lean mean profit machine now kkd 2010 the year of the donut! kkd target $13 kkd party in the usa sweet tasting donut profits go kkd eom

  • Report this Comment On January 08, 2010, at 4:00 PM, NASDAQCZAR wrote:

    kkd is taking off all aboard krispy kreme profit train choo choo donut express kkd to $13 krispy kreme donuts yum yum profits 2010 the year of the donut go kkd! eom

  • Report this Comment On January 08, 2010, at 4:14 PM, NASDAQCZAR wrote:

    i am buying kkd shares everyday this week and next week 2010 is the year of the donut! sweet taste of krispy kreme donut profits, fair value for kkd is $13 target, kkd clean balance sheet now profitable smaller profitable stores, a lean mean krispy kreme donut money making machine, fools are just what they call themselves david gardner sold me a lemon 3DFX TDFX his top stock pick and the next intel whatever went bankrupt, i do the opposite of the fools and make $$$$ paul elliott are you listening to the sweet taste of krispy kreme profits $$$$$$ too bad your a day late and a dollar short like fools always 100% wrong.

    now that kkd is all cleaned up and a winner noone wants it bandwagon guys the fools, same fools who paid $48 didn't want to buy at $2 and change will be paying $13 for kkd later this year, well you can't fool me with this bs article kkd is now delivering on its potential, krispy kreme has what starbux don't have donuts to go along with coffee

    and i love kkd coffee over starbux hands down nothing starbux has can compare to a hot fresh kkd donut and fresh coffee one stop shopping, crooks on wallst won't get my kkd shares from me back til $13 no sale kkd is on a roll now top stock for 2010 is kkd go krispy kreme donuts! eom

  • Report this Comment On January 14, 2010, at 10:31 PM, NASDAQCZAR wrote:

    krispy kreme donuts kkd just issued a poison pill rights dividend, looks like wendys will have to go hostile takeover for kkd, kkd shares moving up after hours how high will wendys bid for kkd???

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