AlexPKeaton wrote:This is the math behind the compount interest:
M = P( 1 + i )^n where n i is the expected return and n is the number of years of investment.
(continuous vs yearly interest calculation is negligable, this is the yearly interest formula so it is slightly conservative but good enough to illustrate my point)
So 1000 over 40 years with a 5% return yields:
M = 1000*(1+0.05)^40 = 7040
But with compound fees, the formula becomes:
M = P(1+(i-f))^n where f is the fee
Therefore assuming a 1.5% fee and a 5% return over 40 years is:
M = 1000*(1+(0.05-0.015))^40 = 3959, a 44% reduction in your total amount. The more years, the greater fee, the greater the loss. But even a realistic 1.5% fee over a more realistic 40 years is a huge loss (44%)
If you were going with a managed fund with a 1.5% fee, in order to match your original 5% return with no fees, you would need to earn 6.5%, a 1.5% greater than an index fund (average) over THE ENTIRE FORTY YEARS OF YOUR INVESTMENT. The odds of this happening are non-existant.
Again, I think your consideration of one factor is clouding the issue. The formula you are using assumes and average annual return, but ignores other factors. Try this one, as it accumulates capital and measures incremental investment: FV = [ ( (1 + i)n ) * PV ] + [ PMT * ( ( (1 + i)n - 1) / i ) ]
Or, in scenario:
If you have 25,000 in your account today, and you contribute 6,000 annually ($3k from you, $3k match) for 30 years, assuming your return is in line with the market (7%, long-term CAGR), with a .5% fee, this is what you can expect to have at the end of 30 years:
If you adjust for a 1.5% fee:
This is ~19% difference. Not a small amount, but lets consider an investment strategy that is more realistic. Lets say that you follow the same scenario for 5 years, and get promoted every 5 years. When you get promoted you add $1000 to your annual contribution, which is actually adding $2k with your match. This is your FV with a .5% fee:
And again, at 1.5:
Still about 20% to fees... I agree its significant, but as I keep saying, its one of many factors in any investment. Also consider that this represents a total of $435k investment, so its still better than sticking it under your mattress. It also indicates that the best way to get a better return is to find a way to invest as much as you can afford.