Do Investment Costs Really Matter? If So, To What Degree?

I have been having nightmares regarding some runaway BIPs I have been dealing with lately. There seems to be a total lack of comprehension as to how negatively costs can impact total return. BIPs, or basis points, represent 1/100th of a percent, so 100 BIPs would equal one percent (1%). This term is used repeatedly by the financial services industry to discuss fees. The word "BIP" sounds harmless, doesn't it? Semantically, it is easily confused with words like "bit" which indicates small, insignificant amount. "BIP" also sounds similar to the word "blip"--a small, often unimportant, flash of light. To the uninformed it is natural to assume that the word "BIP" is also unimportant . Don't be fooled! While a few BIPs may appear to be a small, inconsequential quantity, they can destroy your investment returns.

Before you read this post any further, please take a look at this Google spreadsheet I created: The Tyranny of Compounding Costs on an Annual Investment of $1,000 at 8% from 5 to 35 Years / PDF version here. This spreadsheet illustrates just how costly investment expenses can be. This first example represents the likely returns of portfolio earning 8% annually in the Federal Thrift Savings Plan. This plan is the least costly of any that I am aware of; it charges a fee of 3 bips on total assets. In other words an investment of $1,000 has an expense of 30 cents. That is incredibly low; consequently, the investor is able to capture the vast majority of the portfolio's gains. Since only .03% is charge against the total assets, the investor earns a net return of 7.97% . Over 35 years the Thrift Savings Plans generates only $1,146 in fees. This represents less than 1 percent (actully only .83%) of the market return over 35 years. The TSP is an amazingly efficient retirement savings plan. Here are some observations regarding the rest of the spreadsheet.

1. Over 35 years, a product charging 20 bips manages to generate fees that equal approximately 5.5% of the total porfolio return.
2. A product charging 50 bips ends up with roughly 13% of the portfolio gains.
   
3. A 100 bips fee would mean that 25% of the portfolio's return ended up with the financial intermediaries.
   
4. A product with a 150 bips fee would ultimately consume 35% of the porfolio gains via fees.
5. A product carrying a 200 bips fee would result in a 44% reduction in the portfolio gains.

I have many strong opinions regarding the information in the worksheet.

1. As a rule of thumb, any investment charging more than 50 basis points is entering the realm of BOHICA. I know of no reason to pay more than 50 basis points for any investment.
2. Once an investor hits a 100 bips, the fees become punitive. Should an investor, who puts up all the capital and bears all the investment risk, really have to cut the financial intermediaries in for about 20% of the investment return? I say to Hell with these blood-sucking parasites.
3. I read somewhere (I wish I could remember where) that a retirement plan essentially forefits it tax-deferred benefit when it costs exceed 150 bips. It is easy to comprehend how a low-cost taxable investment could surpass the return of a higher cost tax-deferred benefit. After 35 years, 150 bips more than a third of the portfolio's return; that is quite a handicap!
4. We all stand on the shoulders of giants. I confess that I got the idea for this post from my financial idol--John Bogle. This post is an offshoot of this post which in turn came from Bogle's PBS interview. Here is an excellent related post on John Bogle; be sure to watch the video. It is easy to see why this man is disliked, if not downright hated, by many individuals in the financial services industry.
5. It is interesting to note that if the investment holding periods been longer than 35 years, the cut to the financial intermediaries would have been even larger. Check out this example Bogle presented on his PBS interview.