The Tyranny of Compounding Costs

Bringing awareness to excessive and unnecessary costs and fees has often been a subject of my writings, as it affects many portfolios and so few investors are aware of the “true costs” they are incurring.  On April 23, 2013 PBS Frontline aired a hard-hitting expose´ called The Retirement Gamble.  I don’t know if it will be broadcast again, but you can click here to see a replay from the PBS website.

If you are short on time, skip ahead to about the middle of the program to watch the most important information. The first half is a little melodramatic for my taste. It blends a number of retirement issues and might lead the casual watcher to draw some erroneous conclusions. Even so, the correspondent, Martin Smith, and the producer deserve high praise for bringing to light one of the greatest challenges facing current and future retirees.

In The Retirement Gamble, viewers get to hear from some heavyweight financial commentators, such as Jack Bogle, Jason Zwieg, Zvi Bodie, and Ron Lieber. Whereas most investors understand the concept of compound interest, Mr. Bogle, the founder of Vanguard, talks about the “tyranny of compounding costs.” He quotes a staggering statistic. If an investor incurs 2% of unnecessary fees, over a fifty year period, he or she would give away almost two-thirds of their portfolio!

This information was not news to me, as I’ve often cited examples of the enormous effect that expenses have on a portfolio. In fact, I was out-in-front of Frontline a month earlier when I blogged about then need for 401(k) Awareness. To my delight, the reporter out of curiosity, in an attempt to validate Mr. Bogle’s claim, plugs into a financial calculator a minus 2% return. Sure enough, the hypothetical account loses 63% of its value!

The documentary also strikes at the heart of the problem, when it highlights that 85% of financial advisors are not fiduciaries, which means that the advisor’s loyalty is with the company selling the products and services rather than the investor. Attempts to get financial advice delivered in the best interest of the consumer have been thwarted by a well-financed Wall Street opposition. The investment industry is one of the only areas where consumers have almost no knowledge of the price and quality of what they are buying.

This phenomenon has handicapped the retirement portfolio of millions of Americans. The program scrutinizes 401(k)’s, but the 401(k) should be considered a metaphor for the broader investment landscape. The financial service industry as a whole is systematically extracting wealth from the pockets of investors and moving it into its own pockets. Excessive fees and the lack of objective financial advice is often worse in managed accounts, 403(b) plans, 457 plans, annuities, loaded mutual funds, and other propriety products. An investor is more likely, in my opinion, to suffer the tyranny of compounding costs with these products and services than in the typical 401(k).

For this reason, it wasn’t completely fair for the program to link the 401(k) with a potential collapse of the retirement system. The reality is that the 401(k) provides a tremendous opportunity for many people and many companies offer excellent plans for employees.

Even though I disagree with some of the inferences in The Retirement Gamble, it more than compensates by exposing a problem that rarely gets attention. The program does a tremendous job of raising awareness of the lack of fiduciary accountability in the industry and the potential impact on the future lifestyle of retirees. Who knows, maybe awareness will eventually bring change. I encourage you to watch the video and to forward this article to anyone you think might not be aware of this critical issue.