<THE HARRY JONES PORTFOLIO>

New Help

by Harry Jones

(June 24, 1999) -- We hired a new farm hand and his name is Elizabeth. He's a girl. Or, as Lucinda says, she's a young lady.

She recently turned eighteen and finished high school and in August leaves for the state's big college. It's been nearly one week and she has been here every morning by 5:00 a.m. When she's here ten minutes earlier, she'll eat some breakfast on top of what she already ate at home. Eggs, toast with jam, maybe a piece of bacon. She lives about a fifteen-minute drive away, but it's all one straight road. This one is reliable.

Small Cost = Large Loss

by Jeff Fischer (TMF Jeff)

One reason managed mutual funds underperform is they typically charge fees. Most people don't consider the fees damaging, however. You might hear your uncle say at the dinner table while chomping on a turkey leg, "It's a pretty good fund and the annual management fee is only 3%."

Three percent, ladies and gentlemen, is huge. Compound a hundred dollar bill at 3% for 20 years and you can put it in your pipe and smoke it for the next 40. A 3% annual fee, or even 2% or 1.5%, is an initial small cost that can lead to... ONE... LARGE... LOSS.

Since 1994, the Fool has advised investors to hold the commission percentage rate on any single trade at 2.5% or lower. Following the hawk-like rapid descent of discount brokerage trading fees, though, that percentage can stand to be lowered. It could realistically be lowered to 1% or even less. Many online brokers now charge about $8 per trade. If you buy $1,000 worth of stock, $8 is only a 0.8% fee. Beautiful. You can buy shares of SPY at this cost. (Note, SPY does have a small annual management fee, of sorts, that is automatically figured in the share value and should come to no more than 1% a year. We'll talk about that another day.)

So, regarding fees and mutual funds: how substantial are small fees? In the book Earn More (Sleep Better), The Index Fund Solution, the authors give two examples. The first: "Assume you invest $10,000, with an effective load of 6% and an average total return of 10%. The arithmetic of negative compounding reveals a chilling fact: In less than thirty years, the dollar amount you lose [to fees] will exceed your original investment." [Italics theirs.]

That realization is chilling, but a 6% fee is steeper than the Grand Canyon. Let's consider the average, lower fee. The book continues, "Less obvious is the impact of operating costs, which, for the average diversified non-index stock fund, amount to 1.5%. Add to that an estimated 0.5% in average transaction costs, which are also a drain on return. You now have a total cost of over 2% every year. How hard does that hit?... [John Bogle of Vanguard] points out that over a 25-year-period, a $100,000 investment returning 10% would grow to $1.08 million; the same amount invested at 8% would total $684,847. Operating and transaction costs would have consumed almost $400,000 of your money."

The Fool message boards recently had an even better example, posted by Fool frequenter Dave Fish. In the post, Dave is discussing direct stock plans such as the Drip Port uses, and the loss that occurs when the plans have fees. The small fees used in his examples fit our purpose today perfectly. In his post, Dave writes:

"...[I]nvesting $50 a month, appreciating at 11% and yielding 1%, you'd turn an investment of $30,000 over 50 years into $1,562,575. If there were a $5 fee [every month you invest in the direct stock plan], however, your $30,000 would only grow to $1,406,465. So even though you'd have paid 'just' $3,000 in fees, you'd have $156,110 less value, about a 10% shortfall.

"...If you invested $100 a month instead, a no-fee version would grow to $3,125,288 while a '$5 plan' would grow to $2,969,022, or $156,266 less. In other words, the fee would take 5% of your investment and result in 5% less growth. Obviously, investing larger amounts diminishes the fee in relation to your investment, but the ultimate cost of the fee is duplicated as a reduction in all future growth. The better the stock, the more you lose over time.

"Even if you don't maintain the discipline of dollar-cost averaging, the fee's true bite applies to the entire future of each investment. So if a particular $50 would have grown to $100 in X number of years, a $5 fee ensures that it will grow to only $90 in that time. The same principle applies to every investment hampered by the fee structure... which is why fees are evil...."

A perfect sentiment on which to end. Avoid fees. Fool on!

  Related Links:

 Recent Harry Jones Portfolio Headlines
  08/26/99  Is it a Nifty 500? Part II
  08/19/99  Is it a Nifty 500? Part I
  08/12/99  Illuminating Index Funds, Part Two
  08/05/99  Illuminating Index Funds
  07/29/99  The Foolishness of Index Funds
Harry Jones Portfolio Archives »  


06/24/99 Close
Stock Change Close SPY -1 132.03

Day Month Year History HARRY -0.75% 0.93% 3.45% 3.45% S&P: -1.30% 1.07% 7.62% 7.62% NASDAQ: -1.70% 3.38% 16.48% 16.48% Rec'd # Security In At Now Change 1/4/99 16 S&P Depos 127.63 132.03 3.45% Rec'd # Security In At Value Change 1/4/99 16 S&P Depos 2042.00 2112.50 $70.50 CASH $0.00 TOTAL $2112.50 Yesterday Today Change S&P Depos 133.03 132.03 SPY -1

</THE HARRY JONES PORTFOLIO>

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