Are High Investment Fees and Costs Quietly Stealing Your Retirement?
by Chris Brown, Ph.D., MBA, CFP® and Ron A. Rhoades, JD, CFP®
This is Part 4 of Scholar Financial’s “Evidence-Based Investing” series. To view the entire series, click here. To receive bi-weekly updates on the rest of this series, please join our email newsletter by clicking here.
James and Linda were reviewing their 403(b) retirement accounts one Sunday afternoon, something they’d been putting off for years. Both were veteran educators: James taught high school history for 28 years, while Linda was a university administrator for 25 years. Together, they had accumulated $1,500,000 in their retirement accounts.
Looking through their account documents, James noticed something buried in the fine print: their funds had expense ratios averaging 1.2% per year.
“That doesn’t sound like much,” Linda said.
Then they read about portfolio turnover within their mutual funds, and how the resulting transaction costs, as well as opportunity costs from the cash holdings within the fund, added substantially to the annual fees and cost burden. When they calculated what those fees and costs meant in real dollars over their remaining working years and into retirement, the number shocked them. They were on track to pay many hundreds of thousands in fees and costs over the years.
It was enough to fund extra years of retirement, or a much better retirement. Instead, the money was vanishing into fees they barely understood.
The Most Important Predictor of Returns
John Bogle, the founder of Vanguard and pioneer of low-cost investing, spent decades delivering a message many on Wall Street didn’t want to hear – all-in fees and costs are the single most important predictor of long-term investment returns.(1)
This statement is backed by extensive research. A study by Cooper, Halling, and Yang found a strong negative relationship between mutual fund performance and mutual fund fees.(2) In simple terms, the more you pay, the less you keep.
Think about it this way: if the market returns 8% in a given year and your fund charges 1.5% in fees, and the fund incurs an additional 0.5% costs from transaction and opportunity costs, you net only 6%. These fees and costs – 2 percentage points – may seem small in a single year. But investment returns compound over decades. And so do the losses from high fees and costs.
The Mathematics of Fee Erosion
Consider this example: Two investors, each starting with $1,000,000. Both earn identical gross returns of 8% annually before any fees and costs. Investor A pays 2.0% in annual fees and costs, while Investor B pays 1.0% annually.
After 30 years, with no additions or withdrawals from the portfolio, Investor A has approximately $5,743,491. An impressive sum, due to the effects of compounding.
However, Investor B has approximately $7,612,255. The difference? $1,868,764 – nearly double the original investment amount — lost purely to the fee differential.
This is the cruel arithmetic of investment costs. You pay fees every year, whether the market goes up or down. In losing years, fees and costs still come out. The money you pay in fees doesn’t have a chance to compound for your benefit. It compounds for someone else.
Why High-Fee Funds Rarely Justify Their Costs
Many fund companies often justify charging higher fees by promising superior performance. They have star managers, proprietary research, sophisticated strategies. They may also market their funds through high-cost “full service” brokerage firms. But here is what the research consistently shows: after accounting for fees, high-cost funds typically underperform low-cost alternatives.(1)
This should not be surprising when you understand market efficiency. As discussed in Evidence-Based Investing principles, generating consistent market-beating returns is extraordinarily difficult.(2) The high-fee funds are essentially starting every race with a handicap – they need to beat their relevant benchmarks by enough to overcome their additional costs. Most don’t.
Research by Morningstar and others has shown that expense ratio is actually one of the best predictors of future fund performance.(3) Lower-cost funds have historically been more likely to outperform higher-cost funds—not because they have better stock pickers, but simply because they take less out of returns.
The Hidden Costs Beyond Expense Ratios
Expense ratios are just the beginning. Investors may also face trading costs within funds (as funds buy and sell securities, including the practice of some funds to pay higher commissions to certain brokerage firms – called “soft dollars” – ostensibly in return for research provided by the brokerage firm), tax inefficiency (when frequent trading generates taxable gains), and sales loads (upfront or deferred commissions). Even just within the annual expense ratio, 12b-1 fees (a form of revenue-sharing by funds with brokers) and various manager and administrative fees can often soar quite high.
Evidence-Based Investing emphasizes minimizing all these costs, not just the headline expense ratio. A fund with a modest expense ratio but high turnover and poor tax efficiency can end up costing as much as -or more than – an obviously expensive fund.
What James and Linda Did Next
James was 61 and Linda was 59. They discovered that at age 59½, many educators can roll over their 403(b) and 457(b) retirement accounts to an IRA while still employed—a provision many don’t know exists. (Some 401(k) plans also permit rollovers into an IRA before retirement — also often beginning at age 59½.) Doing so gave them more personal control over investments, often far greater (and better) investment choices, and sometimes lower fees and costs or a better overall investment strategy. This opened up a world of low-cost investment options that weren’t available in their institutions’ plans.
They worked with fee-only fiduciary advisors who specialized in evidence-based approaches. While their advisors charged their own fees, their new portfolio – utilizing carefully selected asset classes and funds/ETFs – had total fees and costs well below what they had previously incurred. The advisors also helped them create a comprehensive financial plan that addressed not just investments, but tax strategies, Social Security timing, and retirement income planning.
“I wish we had known about this years ago,” James reflected. “But at least we caught it before retirement. Every dollar we save in fees and costs is a dollar that stays in our pocket.”
The Evidence-Based Approach to Costs
Evidence-Based Investing doesn’t just suggest minimizing costs — it makes cost control a cornerstone principle. The research is unambiguous: over long periods, fees and costs are one of the few factors investors can control that demonstrably affect returns.
You cannot control what the market does. You cannot know in advance which stocks will outperform. But you can absolutely control what you pay. And given how powerfully costs compound over time, this single decision — choosing low-total-cost investments – may be the most important investment choice you ever make.
Are high fees and costs quietly stealing your retirement? For many investors, the answer is yes. But it doesn’t have to be. Understanding the impact of costs is the first step toward keeping more of what you earn.
About the Authors
Ron A. Rhoades, JD, CFP®
Ron Rhoades is an Associate Professor of Finance at the Gordon Ford College of Business, Western Kentucky University. He also serves as a financial advisor at Scholar Financial, a practice within XY Investment Solutions LLC. With a background as both an attorney and a CERTIFIED FINANCIAL PLANNER™ professional, Ron is a nationally recognized authority on the fiduciary duties of financial advisors.
Chris Brown, Ph.D., CFP®
Chris Brown is a faculty member in the Department of Finance at the Gordon Ford College of Business, Western Kentucky University, and a financial advisor at Scholar Financial, a practice within XY Investment Solutions, LLC. He holds the CERTIFIED FINANCIAL PLANNER™ designation and a Ph.D. in Personal Financial Planning. His research and teaching focus is on behavioral finance, retirement planning, and evidence-based investment strategies.
Endnotes
1. See, e.g., Bogle, J. C. (2014). The arithmetic of “all-in” investment expenses. Vanguard Center for Investor Research.
2. Cooper, M. J., Halling, M., & Yang, W. (2021). The persistence of fee dispersion among mutual funds. Review of Finance, 25(2), 365–402. https://doi.org/10.1093/rof/rfaa023.
3. See, e.g., Morningstar. (2016, October 4). How fund fees are the best predictor of returns; Carhart, M. M. (1997). On persistence in mutual fund performance. The Journal of Finance, 52(1), 57–82. https://doi.org/10.1111/j.1540-6261.1997.tb03808.x; Fama, E. F., & French, K. R. (2010). Luck versus skill in the cross-section of mutual fund returns. The Journal of Finance, 65(5), 1915–1947. https://doi.org/10.1111/j.1540-6261.2010.01598.x; Cremers, M., Fulkerson, J. A., & Riley, T. B. (2019). Challenging the conventional wisdom on active management: A review of the past 20 years of academic literature on mutual funds. Financial Analysts Journal, 75(4), 8–35. https://doi.org/10.1080/0015198X.2019.1611829; Plagge, J. C., & Vanguard Group. (2022). The case for low-cost index-fund investing.
This article is for educational purposes only. It should not be construed as financial, legal, tax, or investment advice, nor as a recommendation to implement any specific strategy, product, or investment. Consult with a qualified financial professional before making investment decisions.
