When I posted a video on how to decide if you should pay off debt or invest earlier this week, a friend (and past client) commented with the following question:
What’s the best way to maximize the returns on investment for your stock market and 401(K) investments?
The answer may surprise you.
First let’s consider the following facts:
Over a 10 year investment timeframe 85% of mutual funds underperform the market. Extend the timeframe to 15 years and 92% of mutual funds underperform the market. In a nutshell, the overwhelming majority of funds underperform the market over the long run and charge you higher fees for that privilege.
But before you say: “You’re saying there’s still a chance …” you have the understand that the 8% that do outperform are not always the same funds. Meaning, a fund could outperform this year but underperform the next.
At this point I want to share one of my favorite quotes ever from Warren Buffett’s long time partner, Charlie Munger:
It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.
That idea is as profound as it is clever. Most “wounds” in the financial realm are self-inflicted. How else can you explain the fact that while the market averages 10% returns over a period of time, investors average 4%.
So what should you do instead? Focus on what you can control: Costs and not doing anything stupid!
The impact of costs on performance is incredible.
Let’s look at a scenario to illustrate it: If you invest $100k earning 6% interest for 25 years with no costs it will turn into $430k . Same scenario but with 2% annual costs and it only turns to $260k.
2% costs = 40% less principal
Let that sink it for a second. That 2% cost may not seem like much but it can devastate your portfolio’s performance. Or put a different way, your fund’s superior strategy would have to outperform the market by 40% just to offset the effects of its fees on your portfolio.
Simple Stupid-Free 3 step strategy to maximize returns in your stock market investments:
- Invest in index funds and ETFs that mirror the market at the lowest possible costs.
- Automate your investments
- Leave them alone
401(K) accounts are a little trickier due to “pay to play” dynamics. That is, the fund has to pay in order to be part of the lineup of funds offered within the 401(K) plan of a corporation. Those fees paid are then passed on to the customer (you) through higher fees charged by the mutual fund.
However, many 401(k) plans have been adding low cost index funds and ETF because employees have been asking for them. So my advice on your 401(K) is to look at your current holdings as well as the other lower cost options within the lineup. Even if your 401(k) isn’t offering the lowest cost funds, you can still dramatically reduce costs and get an allocation that more closely mirrors the market.
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