Small Changes Can Have Big Consequences

August 05, 2013

Many financial planners (this writer included) have resorted to the cup of coffee example at least once during their careers. It usually starts with a simple question such as “how much does a cup of coffee cost these days?” The answers depend on individual tastes and how many fancy iterations of a coffee or latte people can come up with (typically $3 to $5).

You can imagine what comes next…suggestions to brew your own coffee at home, rely on a free cup from your employer (or a caring friend who knows how you behave without caffeine), or simply cut back on consumption all with the purpose of saving money. After all, a thirty-year old saving five bucks a day on coffee would have over $200k by the time they reached age 65 (assuming a moderate 6% annual rate of return). That cup of Joe never seemed to hold so much potential wealth.

The message is simple yet powerful. Small changes can yield significant results. (You can use this Daily Savings Calculator to see the impact of cutting back on small items in your own spending plan.)

But what if instead of changing your coffee drinking habits, you could purchase a cup of coffee for just 26 cents? During a recent trip to Seoul, South Korea, I had a brief layover in San Francisco and my trusted Yelp app identified a nearby coffee truck called the At Cost Café offering inexpensive coffee. I was intrigued and soon noticed this wasn’t just any coffee stand. The coffee truck was a traveling marketing effort funded by the Vanguard Group and designed to create awareness of investment fees and expenses.

It’s hard to imagine any business surviving selling 26 cent cups of coffee but the whole premise was to help people see the markup that takes place when you purchase more expensive mutual funds. The 26 cent cup of coffee was 1/5 of the industry average and representative of Vanguard’s low cost approach to investing. It’s an important message because the reality is that most people don’t have a clue as to what they are paying for their investments. According to data from our soon to be released quarterly research report, less than one in five people have taken the time to complete a fee analysis and believe their investments are at or below industry costs.

Are you giving enough attention to the fees you pay for your mutual fund investments? If not, then investment fees need to be given more attention as you build and maintain an investment portfolio for retirement and other goals. In fact, with so much global economic uncertainty and concerns about stock market volatility there are three main areas of focus that individuals have some control over – asset allocation, taxation of investments, and the costs and fees associated with investing.

Take some time to check your most recent account statement to see what the expense ratios are for your mutual funds. (Expense ratios are recurring fees that represent the total amount of money it takes for an investment company to operate a mutual.)  You can obtain information about your fund’s expense ratio by looking at your investment prospectus or searching sites such as Morningstar or Yahoo Finance.

Then compare them to average funds in their category. The Investment Company Institute reports that the weighted average expense ratio of equity funds was about .77% during 2012.  But some funds have expense ratios that are high as 2%.

With such a large variation in costs, it pays to shop around. If you only have expensive mutual funds in your retirement plan at work, you may want to consider investing a portion of your retirement savings into a traditional or Roth IRA as an alternative.  Just be sure to at least take full advantage of any employer match before looking outside of your 401k because you don’t want to leave any money on the table.

The difference in fees may seem small but they matter more when we look at their impact on investments over the long haul. For example, saving that $5 a day would produce about $43k less at age 65 if they only earned 5% net of fees. So why not purchase mutual funds as close to cost as possible since the savings can be significant over time? Pay attention to your mutual fund expenses and you will assume control over an important element of your investment plan.