A 1% yearly fee sounds like pocket change. On $10,000 invested for 40 years, it costs you about $47,000. This week the course leaves the arena and walks into your paycheck.
Learning objectives. After this week you can (1) explain why low-cost index funds are the default for most investors and compute what a fee costs over time; (2) compute a dollar-cost-averaging average cost; and (3) describe a 401(k), an IRA and an employer match.
Remember this: fees compound against you exactly as returns compound for you.
1) Index funds and the cost of fees
Week 5 showed why: most professional funds trail a broad index over long periods, especially after fees. An index fund simply holds the whole market. A fund's price is its expense ratio, the percent of your money it charges every year: about 0.03% to 0.10% for broad index funds, often about 1% for actively managed ones. Same $10,000, 40 years, 7% market return, Week 2's FV formula:
| Fund | Net rate | Value after 40 years |
|---|---|---|
| Index fund (≈0% fee) | 7% | 10,000 × 1.0740 ≈ $149,745 |
| Active fund (1% fee) | 6% | 10,000 × 1.0640 ≈ $102,857 |
The 1% fee took about $47,000, nearly a third of the ending wealth, and that assumes the active fund matched the market before fees, which most don't.
2) Dollar-cost averaging (DCA)
Average Cost = Total Dollars Invested ÷ Total Shares Bought
DCA means investing the same dollar amount on a fixed schedule, whatever the price. $300 a month at prices of $10, $12 and $8 buys 30 + 25 + 37.5 = 92.5 shares. The average price was $10.00, but your average cost is $900 ÷ 92.5 = $9.73, because fixed dollars buy more shares when the price is low. It also takes "is now a good time?" out of your hands.
3) The accounts: 401(k) and IRA
These are tax-advantaged accounts that hold investments, not investments themselves.
- 401(k): run by your employer and funded straight from your paycheck. Many employers add a match, say 50 cents per dollar on your first 6% of salary. On $60,000, putting in 6% ($3,600) brings $1,800 of match: an instant 50% return.
- IRA: an account you open yourself. Traditional versions take money before tax and tax the withdrawals; Roth versions take money after tax, and qualified withdrawals, growth included, come out tax-free.
Time is the input you can't buy back. At 7%, money doubles about every decade (Rule of 72), so a dollar invested 40 years before retirement grows about 16-fold; one invested 20 years before, about 4-fold.
Quick self-check
(a) $200 a month for two months at $10, then $5. Average cost per share? (b) A 50% match on the first 6% of a $50,000 salary. How much match? (Answers: $400 ÷ (20 + 40) = $6.67, below the $7.50 average price; $3,000 × 0.5 = $1,500.)
Common mistakes
- Dismissing 1%. It is 1% of your money every year, compounded.
- Confusing the account with the investment. An IRA holding cash earns cash returns.
- Waiting for a good time. The market never announces one.
This week in the arena
Take your Total value and project it 30 years at 7% and at 6% with FV = PV × (1 + r)n. The difference between the two is what a 1% yearly fee would cost on a portfolio the size of yours.