Tracing The Slow Decline of Investing Costs

Not too long ago, I wrote a post about why the cost of investing matters so much to the individual investor. In short, costs matter because they substantially erode your investing returns, and paying higher costs in no way guarantees you will receive higher long-term returns.

That’s why the long, slow downward trend in investing costs is worth writing about today. You may have seen recent headlines that the costs charged by financial institutions are sinking to rock-bottom:

The first article is mostly about brokerages no longer charging fees for buy and sell transactions. The second article focuses on fund providers that recently started to offer funds with zero expense ratios. (The expense ratio is the total of all fees and expenses charged by the fund provider while you hold a fund. It’s usually expressed as a percentage of the dollar-value invested in the fund.) What does the bottoming out of these two costs mean for individual investors? Let’s take them one at a time.

Free Trades

There’s a long history of upstart brokerage’s undercutting the trading fees of the well-established brokerages. Today, at least seven large companies offer free trades for stocks, bonds, exchange-traded funds, and mutual funds.

Free trades aren’t a huge game-changer for most investors because trading costs have been pretty minimal for years now. Further, we mindful investors don’t trade much; we buy and hold for the long-term. But we do have to buy fund shares regularly when we’re young and sell some shares to fund living expenses in retirement when we’re old. So, avoiding even small toll charges for access to the markets is definitely a benefit to long-term savers and investors.

Also, mindful investors will often need to regularly reinvest dividends and periodically rebalance asset allocations. Looking at these two portfolio maintenance activities through the new lens of free trades suggests I need to adjust some of my previous mindful conclusions about reinvesting and rebalancing.

Dividend Reinvestment – For years there have been several different ways to reinvest dividends for free. So, my conclusions on reinvesting haven’t changed much with the advent of zero trading costs. When trading costs were more common, reinvesting too frequently in small dollar-value accounts could substantially erode your long-term returns. But now, because it’s so easy to avoid trading fees, reinvesting dividends as frequently as possible always helps compound your wealth.

Rebalancing – Previously, I had concluded that less frequent rebalancing (for example annually instead of quarterly) could generate higher after-cost returns in some cases. But now with free trading, if you’re going to rebalance, you can do it as often as is logistically reasonable. My long-standing caveats about rebalancing are still valid, including that:

There’s no consistent benefit from rebalancing mixed stock/bond portfolios

Rebalancing can boost the returns from all-stock portfolios, but this benefit is largely confined to portfolios with the most volatile and least correlated types of stocks.

Hidden Costs – Also, it’s worth noting that most of these brokerages still have hidden costs associated with each transaction. The main hidden cost is that the brokerages may give you a share price that’s a little bit higher than the true market price. The brokerage can then cash in on the difference between these two prices using nearly instantaneous computer trades. Unfortunately, it’s nearly impossible to quantify how much this costs you over the long run. So, you can regard these hidden costs as the unavoidable minimum required to invest in today’s markets and then forget about them.

Declining Fund Expense Ratios

The long slow descent of fund expense ratios mirrors the decline of trading fees. Here’s a graph from Vanguard showing the history of average fund expense ratios.

Since about 1987 the expenses associated with stock and bond funds have been decreasing, with the industry average now approaching 0.5%. And as the graph suggests, Vanguard’s below-average costs have been putting pressure on other fund providers to reduce their expenses. As a result, we’re starting to see some major fund providers like Fidelity testing out zero expense index funds.

This trend doesn’t change any of the primary investing strategies discussed here at Mindfully Investing. It’s still mindful to invest in a moderately diversified set of low-cost stock index funds. It’s just that now you have an ever-greater selection of extremely low-cost, or even zero-cost, options to choose from.

What’s The Benefit?

The continuing trend in lower costs requires only minor adjustments to a mindful investing approach. But what’s the aggregate benefit of these declining costs to individual investors? The answer to that question depends to some extent on your specific situation. So, out of sheer self-interest, I decided to look at an example that applies to an early retiree like me.

I retired at age 52 and given today’s life expectancy rates, I could easily live until age 92, which means 40 years of investing and living off the proceeds. Other assumptions in my example include:

A moderately diversified stock portfolio with an average expected future annual return of 5%

A $1 million starting value
A 4% annual withdrawal rate, inflation-adjusted at an annual rate of 2%

I then took this base case and calculated the account value over time using two different cost scenarios. The “2010” scenario uses costs appropriate to about 10 years ago, and the “2020” scenario uses costs more in line with today. Here are the details:

- 2010 scenario – $10 fee for each trade, 4 trades per quarter for dividend reinvesting, 4 trades per quarter for rebalancing, and a 0.7% expense ratio across all funds in the portfolio.
- 2020 scenario – $0 fee for each trade (so the number of trades is irrelevant), and 0.1% expense ratio across all funds in the portfolio.

The yellow and orange lines in this graph show the trajectory of the account values for both the 2010 and 2020 cost scenarios. And for comparative purposes, the gray and blue lines show the growth of account values for the same two cost scenarios but assuming no withdrawals, which might be more interesting to un-retired readers.

Looking at 4% withdrawal scenarios, we can see that, with the new 2020 costs (yellow), our example retiree still has money after 40 years. But with the old 2010 costs (orange), our retiree runs out of money around year 35. So, the benefit of lower costs is that the same-sized nest egg will last several years longer into retirement. Alternatively, you can reach the same investing goal with less money.

And if you’re looking at a pure growth scenario, the difference in account values between 2010 costs (blue) and 2020 costs (gray) is more than $1.3 million over 40 years! Here’s a bar graph showing the end value of each scenario to better illustrate the outcomes.

Regardless of your specific situation, cost competition on Wall Street is putting substantially more money in your pocket over the long run.

Financial Adviser Costs

Trading fees and fund expenses apply to every investor. However, some investors have even more expenses, the most common of which is the cost of using a financial adviser. An adviser helps you with portfolio selection, maintenance activities, and picking funds, which will likely incur transaction fees and fund expenses. But they also charge a fee on top of all that in return for their sage advice.

A working assumption of Mindfully Investing is that you’re a do-it-yourself investor and don’t use an adviser. Although there’s nothing categorically wrong with using a financial adviser, the added costs need to be factored into your investing goals. Michael Kitces summarized recent data on adviser costs and produced this graph.

In this case, the “underlying fee” shown in orange refers to the transaction fees and fund expense ratios that I covered in the first half of this post. The “AUM fee” refers to the percentage that the adviser charges on top of the other costs. So, it’s not unusual for a financial adviser to charge an additional 0.6% to 1%. And therefore, even as recently as 2017, the all-in costs of using an adviser can get close to 2%!

If you add advisor costs to either of the withdrawal scenarios shown in the previous graphs, then you would run out of money before meeting a 40-year retirement goal. Unless the decline in adviser costs catches up quickly to other decreasing costs, advisers are starting to represent the lion’s share of potential investing costs. So, if you’re thinking about using an adviser (or already do) it’s increasingly important to examine how the adviser’s costs would impact your investing goals over the long term.

Opportunity Costs

I typically don’t write a lot about opportunity costs, because it can quickly become an economics quagmire about which costs to include and how to calculate them. However, the interest rate on cash in your portfolio is one obvious opportunity cost that’s very relevant to “older” mindful investors. I’ve argued “older” investors should hold up to 20% of their portfolio in high-interest cash accounts for 5 to 10 years bracketing their retirement date. But most cash vehicles in brokerage accounts pay a pittance in interest. For example, my brokerage pays 0.09% interest on cash, but my online bank is paying 1.7%, nearly 20 times higher.

So, it’s notable that Fidelity¹ (and probably some other brokerages) has recently started advertising interest rates for brokerage account cash in the 0.8% to 1.3% range. Holding cash in a low-interest account is a lost opportunity cost that’s becoming increasingly easy to avoid. Over the first 10 years of retirement, the difference in interest produced by $200,000 in an old low-interest versus a new relatively high-interest brokerage account is significant. This table tells the tale.

Scenario (starting with $200K)	Account Value After 10 Years	Account Value After 40 Years
Old Interest Rate = 0.09%	$201,626	$207,141
New Interest Rate = 1.3%	$224,654	$330,977
Difference	$23,029	$123,836

This example isn’t super realistic, because it assumes simple compounding with no withdrawals or new deposits over time. Nonetheless, it gives you a sense of the opportunity cost that can accrue in just 10 years. And although it would be decidedly un-mindful to hold a cash bucket for 40 years, if you did, the opportunity cost of using an old-style cash brokerage account becomes relatively huge.

Conclusions and The Future

Clearly, searching out the lowest investing costs is still inherently mindful and can help you attain your investing goals. But because costs are continuing to decline across the board, a relatively low-cost option from yesterday may morph into a relatively bad deal by tomorrow. For this reason, it makes sense to do some comparison shopping about once a year on brokerage account fees and fund expenses. The more you can drive down your costs, while sticking to a mindful investing plan, the greater your chances of success. But don’t forget to consider the tax implications of selling one fund for another lower-cost fund, particularly if your working in an account that’s not tax-advantaged.

When I first started dabbling in stocks in the early 1990s, few people questioned the idea that you might have to pay $100 for a single transaction or 2% in fund expenses. But today, those costs seem preposterous. And so, I wonder how extreme these cost trends may get in the future. Some companies have started trying out funds with negative costs. This means the fund providers pay you to buy their funds!

Whether negative costs will become a standard offering from the fund industry has yet to be seen. But to some extent, reversing the flow of investing costs makes sense to me. I always wondered why the bank will pay you interest to hold your money², but brokerages, fund providers, and financial advisers make you pay for the privilege of potentially losing all your money in the markets.

Why shouldn’t these investing companies pay you for holding your money just like the banks do? The company that invents a way to make a consistent but modest amount of money from assets under management while paying investors a few pennies above and beyond at-risk market returns will disrupt the entire finance industry. Although I’m not sure a scheme like that is even allowed under today’s finance regulations, I’d be very interested in participating, assuming a reputable firm was involved. But until then, we’ll just have to content ourselves with diligently exploiting and pocketing the additional returns that come with the long, slow decline of investing costs.

1 – I have no affiliation or advertising relationships with Fidelity. I just happened to notice their adds on television. I’m sure Fidelity won’t be the only brokerage trying to attract customers this way, and the options for higher interest brokerage accounts will likely be expanding soon.

2 – Of course, when the Fed started severely cutting interest rates in the 2000s, banks cut depositor interest payments, and they’ve never really recovered. While bank interest today is best viewed with a magnifying glass, it’s still better than paying the banks to hold your money.