When investing, there are three to keep in mind that can erode the purchasing power of each dollar that we have:
(1) The first one is inflation. If inflation runs at 4.0% annually, that means it will take $1.04 in 2014 to buy what cost you $1.00 in 2013.
(2) The second thing is taxes. If you own 1,000 shares of ExxonMobil in a taxable account, you will receive $2,520 in annual dividends. But, if you are in the 15% tax bracket, you will have to send $378 to Uncle Sam, effectively giving you $2,142 in oil well money from Exxon that you can use to spend as you please.
(3) The third way that you can lose money is by paying mutual fund fees. If you have $100,000 in an account that charges a 1% annual expense fee, you are paying someone else $83 per month in perpetuity to manage your money, and that figure will only grow up as your assets grow. Think of it like this: to break even, a management team would have to grow your assets by at $1,000 more than you (if left to direct your own investments) to be worth the cost.
Incidentally, this is a reason why the famous banker JP Morgan hated John Rockefeller back in the day. Morgan was used to getting his hands on other people’s money and charging them 0.5-2.5% of the total amount each year for the rest of their life. Rockefeller resisted these arrangements and was only willing to pay flat fees upfront, and this infuriated Morgan. Eventually, Rockefeller’s oil operations became so vast that he could fund all of his expansion efforts from his own profits, but there was a point in time in which Morgan was mad as hell that he couldn’t get an asset override on Rockefeller’s wealth, and you better believe there is a take-home lesson in that anecdote.
While I’ve got my mind on oil, let’s take a look one of the most successful energy mutual funds out there today, Icon Energy. These are the fund’s top seven holdings:
Take a look at that. 9.28% of the fund is in Chevron and 8.83% of it is in ExxonMobil. Not to mention another 9.39% is in Conoco Phillips and its recent spinoff Phillips 66. At least 27.5% of the fund is in a combination of four stocks that we could easily pick out ourselves. Exxon Mobil makes $35 billion in annual profits across 48 different countries. It has been paying out an annual dividend tracing back to its Standard Oil roots with John Rockefeller in 1882. Do you really have to pay a management team 1.23% of your assets to figure out that Exxon, Chevron, Conoco, and Phillips 66 are good holdings in the energy sector?
Those fees add up—let’s pretend you’re near retirement, have that proverbial million-dollar portfolio, and want 15% of your retirement assets in energy companies.
If you put $150,000 into the Icon Energy Fund (ICENX), you have to give up 1.23% of your assets each year. That is $1,845 in fees for the first year. If you stuck with the Icon Energy Fund for a decade, you’d be paying at least $18,450 in fees to the Icon Energy management team.
Now let’s say you decided to be a self-directed investor and split that $150,000 into the obvious oil supergiants like Exxon Mobil, Chevron, Conoco, Total SA, Royal Dutch Shell, BP, and Phillips 66. What would your costs be in that situation? Assuming you used a discount brokerage house like Charles Schwab and paid about $9 per trade, you’d be looking at a $63 fee right off the bat, and no costs thereafter as you collected your big oil dividends without any interference from a third-party middleman.
Over a ten-year period, there is a huge difference between $63 in fees and $18,450 in fees. This is a reason why the 401(k)’s for a lot of people seem to go nowhere over a ten-year period. Giving up 1-2% of your wealth each year adds up in ways you don’t want to know over a ten, fifteen, twenty year period. If you just owned the underlying assets directly, you would cut out all of those obnoxious fees that act like a tapeworm on your portfolio, slowly siphoning off your long-term wealth. The greatest indignity of it all is that many of these funds that charge 1-2% end up owning the same companies that you or I could figure out by applying a seventh grader’s level of common sense.
This website is about getting out of the habit of transferring your wealth to other third parties on a regular basis and shifting the balance of power so that *you* have hundreds of dollars showing up in your checking account on a regular basis. With the exception of Social Security and a pension for a few of you reading this, your stock portfolio is what you will have to rely upon to make your dreams of financial independence come true. Don’t let others receive an override on your hard-earned assets.