Earlier this week, I polled over twenty financial experts about how you should invest your first $1,000.
One common theme among their answers was that you should consider a low cost investment, usually an index fund of some kind.
That recommendation is nearly universal and it's for a very simple reason —
The most important number in investing is the fee.
The more you pay in fees, the less you'll have in your investment for it to grow!
It sounds tragically simple. Almost too simple.
Even small differences in fees can have huge differences in your wealth because of how long your investments will grow. Take a quick peek at this chart from Vanguard, which looks at a $100,000 initial investment with a 6% reinvested return:
A small difference becomes a huge difference in 10, 20, and 30+ years!
Review Your Fees Right Now!
Retrieve the prospectus of all your funds and see what your fees are, the important ones are:
- The expense ratio – that's how much the fund will charge you each year in fees.
- The sales load (sales commission) – the commission when you buy or sell the fund. A front-end load, or front load, means you pay a fee when you buy the fund (this is on top of any transaction fee you may pay). A back-end load is a fee you pay when you sell shares of the fund and usually has a time decay. For example, if you sell shares within 5 or 10 years, you're charged a back-end load but if you wait beyond that period, there's no back-end load. A deferred load is a fee you pay when you sell shares of the fund and has no time limit, but typically gets lower the longer you hold shares.
- Finally, no load means no sales commission.
Now compare those fees with what you can get at a low-cost company like Vanguard or Fidelity.
Would you be shocked to learn that Vanguard's S&P 500 Index Fund (VFIAX) only charges you 0.04% with no load?
Fidelity's 500 Index Fund (FXAIX) charges a 0.15% expense ratio with a $0 minimum.
Oh, did I mention that many of the low-cost brokers don't charge administrative or other account maintenance fees? Vanguard doesn't. Fidelity doesn't.
The key takeaway from this post isn't that you should shed all other investments and plow your money into low-cost index funds.
You should still hold diversified investments and sometimes those investments will be expensive.
Vanguard has a Vanguard Explorer Fund which aims to invest in small U.S. companies with growth potential. Higher risk, higher reward, but also more expensive. The Investor Shares have an expense ratio of 0.49%. It invests in smaller companies, which is something you won't get from an S&P 500 Index fund.
If you want international exposure, it'll cost you more.
The lesson isn't to go cheap, it's to go cheap when the cheap option performs just like an expensive one!
Here's an example — I don't understand why anyone is invested in the Rydex S&P 500 fund (RYSOX). It seeks to match the performance of the S&P 500 but charges an expense ratio of 1.60%! (oh, it also has an initial sales commission, front load, of 4.75% — that's insanity!)
You can't predict the future. You won't know how your investments will fare. But you can control how much you pay. Never overpay.
(this is also why anything you need in the near future should be kept in a safe short term investment)
As the old adage goes, fund your retirement, not your broker's!