After three months, my $1,000 investment portfolio, nicknamed “Feemaggeddon,” is lagging. This portfolio is part of an investing challenge, the “Grow Your Dough Throwdown.” It’s a lighthearted competition featuring several top financial bloggers.
I have two goals with this portfolio. The first is to test a specific popular investing philosophy. Among those who offer advice about choosing stocks for investing, one oft-repeated technique involves investing in companies whose products the investor uses each day. That’s how I decided to create a portfolio consisting of Microsoft, Canon, Apple, Honda, and Samsung. I couldn’t invest directly in any of these companies except for Microsoft, but I chose good approximations for the others, as I explained in my initial investing challenge report.
The second goal is to highlight the effect of trading fees. Brokerages, whether they consider themselves “discount brokerages” or “full-service brokerages,” or avoid labels at all, earn their revenue from investors in several ways. One source of revenue is the commission, a fee paid for every transaction, whether it’s a stock purchase or a stock sale, and whether it’s a simple market transaction or something more complicated like a limit order or an option.
The biggest investing mistake I ever made.
I want to illustrate the effect of fees because of a very significant mistake I made more than ten years ago. But before that point, some background. When I was a young kid, I received savings bonds as gifts. They didn’t amount to much, although I’m sure I’d have been pleased at the time if I had even known about the gifts. My parents deposited the bonds and eventually, on a banker’s advice I assume, invested the money in a mutual fund, AIVSX.
When the account was transferred to me, my intention was to use it to pay part of my student loan debt. But I didn’t touch it for a few months. During that time, I was starting to read more about managing my own money, and I decided that I would use the dollar-cost average technique to invest more. I transferred the account to Wachovia Brokerage and began adding $100 a month to the same fund, AIVSX.
In general, this is a great idea. My income wasn’t very significant, and investing a little each month in a stock market mutual fund for the long term is a great idea for building wealth. Dollar-cost averaging is a good plan when you don’t have a lump sum to invest at the very beginning.
Here’s where the problem lies. AIVSX, while it was a highly-rated mutual fund at the time, carries a load fee. This is a front-end sales charge, a fee that all investors pay each time they invest in the fund. AIVSX carries a 5.75% load fee. So with the $100 I invested every month, I was only getting $94.25 worth of stock. And this was hidden in the transaction history. When I looked at the statements, I didn’t see a fee being subtracted. The brokerage hides this fee by increase the price of the stock (on the transaction history) by 5.75%.
The only way I realized I was paying a premium was when I started to look at the fund price chart in Quicken. Quicken downloads official daily prices for stocks and funds, but if a transaction occurs on a certain day, it will use the transaction price in the chart rather than the official price on the exchange. I started getting suspicious when I saw large price spikes on the days I invested the $100 in AIVSX.
In June 2003, I realized I had been wasting my money for about six months. I learned about front-end loads, a lesson I somehow missed while first learning about individual investing. I thought I was safe because Wachovia did not charge any commissions for buying mutual funds, but they were still charging the load fee, hidden inside the investment. An investment that loses 5.75% at the exact instant of purchase needs to earn 6.1% just to break even.
That’s close to the long-term annual average of the stock market after taxes. (Economist and author Jeremy Siegel indicates stock market investors expect to earn 6.5% to 7% in the stock market over the long-term.) Therefore, if it takes a year to break even, your performance is just average.
With this knowledge about how I was playing a game I was destined to lose, each month paying a 5.75% premium, I ceased the automated $100 investments in AIVS and learned about no-load index funds. The following month, I founded Consumerism Commentary to make better decisions about my finances.
How fees destroy your real performance.
Front-end load fees, back-end load fees, 12b1 fees, transaction fees, commissions, expense ratios, and asset management fees are all ways individual investors are kept on the losing side of wealth growth. The financial industry wins because they earn money regardless of the performance of the stocks. People seem to forget to consider fees when they talk about the investment performance. Investment fees are usually built into personal reports, but when the media reports on the performance of a stock, they don’t talk about investors.
For example, Microsoft’s stock price is up 9.57% year-to-date as of March 31, according to Google Finance. But actual investors in Microsoft will see internal rates of return that vary if they bought or sold stock during that period. If I purchased three shares of Microsoft at the beginning of the year for a fee of $7, I would have paid $118.48 for those three shares. If I sold all three shares on March 31 for a fee of $20, I would have proceeds of $102.97. So that reported 9.57% gain in Microsoft is really a 13.09% immediate loss.
Here’s how my investments are doing when I take into account the $6.95 I paid for each stock purchase in this portfolio.
One reason some of the other participants in the investing challenge are doing well is because they used a platform that was offering free trades — no commissions — for a limited time. If you can take advantage of opportunities like that, there’s little to lose, if you also don’t get caught in buying and selling. Just make sure that you’re also paying attention to the commissions when you sell, as well.
Carl Richards calls the difference between the reported, publicized returns of the stock market and the actual returns people see the “behavior gap.” And it gets even worse the more people trade and try to time the market. The timing of my purchase in this case was defined by the rules of the investment challenge (buy at the beginning of the year), but as kids throughout the country are getting involved in the stock market game, which encourages watching stock performance on a daily basis and buying and selling based on those prices, and as adults take that same strategy with their “investing,” the mythology of the stock market performance continues.
The only way to get those mythical high long-term returns is to invest at the beginning and stay invested, avoiding all fees as much as possible.