Once you’ve figured out what a mutual fund is, it won’t be long until you hear someone blowing a gasket about their high relative costs. Most investors are oblivious to it, but it’s easy to show how ignoring fees over the long run can cost you tens of thousands of dollars.
Blogger Michael James on Money coined the MERQ metric (Management Expense Ratio per Quarter Century). It quantifies the seemingly innocuous annual drag of mutual fund fees over a period of 25 years: a fund with annual expenses of 2.36 per cent would consume 44.96 per cent of your portfolio over 25 years. (I explain that more fully here.)
Over long periods of time, it’s clearly something to blow a gasket over. But when you’re starting out, fees aren’t that important. A far bigger concern is how much money you are putting away.
For example, someone who is contributing $200 a month into a high interest savings account that pays 1.5 per cent interest per year would have $25,895 after 10 years. Cut that contribution to $100 a month and to end up with the same amount of money you would need an annualized rate of return north of 14 per cent.
That kind of return over 10 years is possible, but not very likely. And it certainly wouldn’t come without exposing yourself to some serious risk in your portfolio.
The moral of this story is that assuming your portfolio is sufficiently prudent, the focus of a small investor should be on putting money away, not fees and not portfolio strategy. The reading material on various investment strategies and portfolio costs takes a long time to wade through.
Far simpler - in theory - is learning to spend less than you earn, if you want to run a surplus. If you want a bigger surplus, you have to work harder with your budgeting to accomplish it, but it’s not rocket science.
Once you start socking away money, you have some time to figure out what portfolio is right for you, and how to reduce costs. Eventually, those variables will become incredibly important but for new investors, focusing too much on figuring out the perfect portfolio can actually get in the way of having a bigger portfolio.