MONEY Master the Game: 7 Simple Steps to Financial Freedom (18 page)

One exciting strategy we will introduce allows us to make money when the market (index) goes up, yet it simultaneously guarantees that we will not lose our original investment if the market goes down. The catch? You don’t get to capture or participate in
all
of the gains.

Most are in disbelief when I explain that there are tools out there that can guarantee that you don’t lose while still giving you the ability to participate in market “wins.” Why haven’t you heard of them? Because they are typically reserved for high-net-worth clients. I will show you one of the only places where the average investor can access these. Imagine your friends with their baffled and even suspicious looks when you tell them you make money when the market goes up but don’t lose money when it goes down. This strategy alone can completely change the way you feel about investing. It’s your safety rope while climbing the mountain when everyone else is “white knuckling” it with hope. Imagine the feeling of certainty, of peace of mind, knowing that you aren’t at risk. How would this change your life? How would you feel when you open up your monthly statements? Would you be gritting your teeth or feel calm and collected?

We’ve only scratched the surface of the incredible insights and tools that lay ahead, so you must stay tuned. But for now, we can remember the following:

• Stocks have by far been the best place to be for long-term growth over time.

• Stocks are volatile. In the pages ahead, you will learn from the “market masters” how to “smooth out the ride” by investing in and diversifying across multiple different indexes.

• Don’t be sold that someone is going to beat the market. Instead, align yourself with the market! Once you put your indexing plan in place (which we will do step by step), you won’t have to spend your time trying to pick which stock to buy because the index will have done it for you. This will save you a tremendous amount of time and angst in trying to pick a winner.

• Begin to think like an insider! Never again will you tolerate the “herd” mentality in your own life.

FEES ON FEES

By tapping into the power of indexing, by passively owning the market, you are also combatting our second myth. Nearly every person I ask doesn’t know
exactly
how much he or she pays in fees. I’ll admit, I also didn’t know at one stage in my life. The fee factories have become masterful at either hiding the fees or making them appear negligible. “No big deal.” Nothing could be further from the truth. When climbing the mountain of financial freedom you will need every bit of forward progress to succeed. You can’t afford to take two steps forward and one step back by letting excessive fees drain your account. So the
real
question is: Are you funding
your
retirement or
someone else’s
? Turn the page now and find out!

4
. Active managers rely on their own judgment and experience in making investment decisions on what stocks or bonds to buy, hold, and sell. They believe its possible to outperform the market with this approach.

CHAPTER 2.2

MYTH 2: “OUR FEES? THEY’RE A SMALL PRICE TO PAY!”

The mutual fund industry is now the world’s largest skimming operation, a $7 trillion trough from which fund managers, brokers, and other insiders are steadily siphoning off an excessive slice of the nation’s household, college, and retirement savings.”

—SENATOR PETER FITZGERALD, cosponsor of the Mutual Fund Reform Act of 2004 (killed by the Senate Banking Committee)

INSULT TO INJURY

Nothing is more infuriating than to be told one price but then realize that you are paying another. You agree on the price of a new car, but when it comes down to signing the documents, a couple thousand in fees magically appear. Or you check out of a hotel and discover an additional resort fee, a tourism tax, a wireless internet fee, fees for towels—you get the point.

It’s frustrating. We feel trapped. We feel snowed. Strong-armed or simply deceived into paying more than we should. With the help of fine print, the $13 trillion mutual fund industry is hands down the most masterful in the craft of hiding fees.

In a
Forbes
article entitled “The Real Cost of Owning a Mutual Fund,” Ty Bernicke peels back the layers to dissect the
actual
cost and arrives at a heart-stopping total:

The average cost of owning a mutual fund is 3.17% per year!

If 3.17% doesn’t sound like a big number to you, think of it in light of what we just learned about becoming or owning the market. For example, you can “own” the entire market (let’s say all 500 stocks in the S&P 500) for as little as 0.14%—or as the investment world calls it, 14 basis points (bps).
That’s just 14 cents for every $100 you invest. (Just a quick FYI for you insiders: there are 100 basis points in 1%, so 50 basis points is 0.5% and so on.)

Owning the entire market is accomplished through a low-cost index fund such as those offered through Vanguard or Dimensional Fund Advisors. And we already know that owning the market beats 96% of all the mutual fund “stock pickers” over a sustained period. Sure, you might be willing to pay 3% to an extraordinary hedge fund manager like Ray Dalio, who has a 21% annualized return (before fees) since launching his fund!
But with most mutual funds, we are paying nearly 30 times, or 3,000%, more in fees, and for what? Inferior performance!!!
Can you imagine paying 30 times more for the same type of car your neighbor owns, and it goes only 25 mph to boot!

This is exactly what is happening today. Two neighbors are both invested in the market, but one is shelling out fistfuls of cash each year, while the other is paying pennies on the dollar.

SAME RETURNS, DIFFERENT RESULTS—THE COST OF IGNORANCE

Three childhood friends, Jason, Matthew, and Taylor, at age 35, all have $100,000 to invest. Each selects a different mutual fund, and all three are lucky enough to have equal performance in the market of 7% annually. At age 65, they get together to compare account balances.
On deeper inspection, they realize that the fees they have been paying are drastically different from one another. They are paying annual fees of 1%, 2%, and 3% respectively.

Below is the impact of fees on their ending account balance:

Jason: $100,000 growing at 7% (minus 3% in annual fees) =
$324,340;

Matthew: $100,000 growing at 7% (minus 2% in annual fees) =
$432,194;

and

Taylor: $100,000 growing at 7% (minus 1% in annual fees) =
$574,349.

Same investment amount, same returns, and Taylor has nearly twice as much money as her friend Jason.
Which horse do you bet on? The one with the 100-pound jockey or the 300-pound jockey?

“Just” 1% here, 1% there. Doesn’t sound like much, but compounded over time, it could be the difference between your money lasting your entire life or surviving on government or family assistance. It’s the difference between teeth-clenching anxiety about your bills or peace of mind to live as you wish and enjoy life. Practically, it can often mean working a full decade longer before you can have the freedom to quit working if you choose to. As
Jack Bogle has shown us, by paying excessive fees, you are giving up 50% to 70% of your future nest egg.

Now, the example above is hypothetical, so let’s get a bit more real. Between January 1, 2000, and December 31, 2012, the S&P 500 was
flat.
No returns. This period includes what is often called the “lost decade” because most people made no progress but still endured massive volatility with the run-up through 2007, the free fall in 2008, and the bull market run that began in 2009. So let’s say you had your life savings of $100,000 invested. And if you simply owned, or “mimicked,” the market during this 12-year period, your account was flat and your fees were minimal. But if you paid the 3.1% in average annual fees, and assuming your mutual fund manager could even match the market, you would have paid over $30,000 in fees!!! So your account was down 40% (only $60,000 left), but the market was flat.
You put up the capital, you took all the risk, and they made money no matter what happened.

I AM SMARTER THAN THAT

Now, you might be reading along and thinking, “Tony, I am smarter than that. I looked at the ‘expense ratio’ of my mutual fund(s), and it’s only one percent. Heck, I even have some
‘no load’
mutual funds!” Well, I have some swampland in Florida to sell you! In all seriousness, this is the exact conclusion they want you to arrive at. Like the sleight-of-hand magician, the mutual fund companies use the oldest trick in the book: misdirection. They want us to focus on the wrong object while they subtly remove our watch!
The expense ratio is the “sticker price” most commonly reported in the marketing materials. But it certainly doesn’t tell the whole story . . .

And let me be the first to confess that at one stage in my life, I thought I was investing intelligently, and I owned my share of the “top” five-star actively managed mutual funds. I had done my homework. Looked at the expense ratios. Consulted a broker. But like you, I am busy making a living and taking care of my family. I didn’t have the time to sit down and read 50 pages of disclosures. The laundry list of fees is shrouded within the fine print. It takes a PhD in economics to figure it out.

PhD IN FEES

Just after the 2008 crash, Robert Hiltonsmith graduated with a PhD in economics and decided to take a job with policy think tank Deēmos. And like all of us, nothing he learned in college would prepare him for how to create a successful investment strategy.

So, like most, he started making dutiful contributions to his 401(k). But even though the market was rising, his account would rarely rise with it. He knew something was wrong, so he decided to take it on as a research project for work. First, he started by reading the 50-plus-page prospectus of each of the 20 funds he invested in. Incredibly boring and dry legalese designed to be, in Hiltonsmith’s words, “very opaque.”
⁵
There was language he couldn’t decipher, acronyms he hadn’t a clue what they stood for, and, most importantly, a catalogue of 17 different fees that were being charged. There were also additional costs that weren’t direct fees per se but were passed onto and paid for by the investors nonetheless.

To better shroud the fees, Wall Street and the vast majority of 401(k) plan providers have come up with some pretty diverse and confusing terminology. Asset management fees, 12b-1 fees/marketing fees, trading costs (brokerage commissions, spread costs, market impact costs), soft-dollar costs, redemption fees, account fees, purchase fees, record-keeping fees, plan
administrative fees, and on and on. Call them what you want. They all cost you money! They all pull you backward down the mountain.

After a solid month of research, Hiltonsmith came to the conclusion that there wasn’t a chance in hell that his 401(k) account would flourish with these excessive and hidden fees acting as a hole in his boat. In his report, titled
The Retirement Savings Drain: The Hidden & Excessive Costs of 401(k)s,
he calculated that the average worker will lose $154,794 to 401(k) fees over his lifetime (based on annual income of approximately $30,000 per year and saving 5% of his income each year). A higher-income worker, making approximately $90,000 per year, will lose upward of $277,000 in fees in his/her lifetime! Hiltonsmith and Deēmos have done a great social good in exposing the tyranny of compounding costs.

DEATH BY A THOUSAND CUTS

In ancient China, death by a thousand cuts was the cruelest form of torture because of how long the process took to kill the victim. Today the victim is the American investor, and the proverbial blade is the excessive fees that slowly but surely bleed the investor dry.