We’ve learned that compounding returns can turn small savings into large amounts of money. Well, guess what? There’s an incredibly important flip side.
Compounding fees will equally turn small costs into large losses over time!
Nearly all investment products charge an annual management fee, sometimes in the neighborhood of 2%. At first glance, that might seem reasonable—after all, if you’re earning 8%, what’s the problem in paying 2% in fees?
Turns out it’s a very, very big deal!
Imagine you found an investment with an annual return of 8% which costs 2% in annual fees. If you invested $10,000, that 8% compounding return would grow your money in 50 years to $469,000. But that 2% fee will cost you dearly. After paying those fees, your account balance in 50 years would be reduced to $184,000.
Pause for a moment to reflect on that—that little 2% annual fee reduced your investment balance by over 60%!
It’s critical that we minimize the costs of our investments. Fortunately, it so happens that some of those passive investments we discussed in the last chapter are very economical, with fees as low as 0.04%.