Negative compounding? Is there such a thing? What is it?

 

Why is self-directed investing (do-it-your-self investing) such an important habit of highly successful investors? Why not buy an exchange-traded fund (ETF) run by professionals for the seemingly low cost of 1% per year in fees? Compared to restaurant tipping which commonly runs between 15% to 18%, a 1% fee does seem low. The concept of negative compounding shows that a 1% fee is far from being low.

Before looking at the seemingly low 1% per year in fees, follow the link to review the run by “professionals”¬† aspect. That will show you what you are getting for what you are paying.¬†Alternatively, you can save yourself the time needed by taking our word that professionals’ performance record is nothing to be proud of.

Now, let us look at the seemingly low cost of 1% per year in fees. That 1% per year is subtracted every year from investors’ entire mutual fund including investors’ contribution that year as well as all the compounding growth which has taken place over the life of the fund. Investors can call it negative compounding.

Investors lose 1/3 to 1/2 of their gains to the managers of the fund.

The table below shows the result if an investor puts $1,000 a month into an investment account each year for 30 years, earns an annual 7% return on average and pays a fee of 1%.

Annual fees Value of account Lost to fees
1% $979,256.24 $393,618.60

The arrangement is a wonderful deal for the managers. They take no risk. They get paid even in down markets when investors lose. They get a significant portion of the gains in rising markets.

The Monday Morning Millionaire Program shows how to outperform over 90% of professional managers over the course of a market cycle and keep the amount lost to fees.

We are looking here at the “humble arithmetic” which John Bogle frequently wrote about.

Do it yourself, avoid negative compounding and prosper.

 

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Dr. Milan Somborac

The Monday Morning Millionaire Program supports do-it-yourself (DIY) investors which I have been for over 50 years. About my team and me