Saturday, October 11, 2014

A SIMPLE DIY Centered Way to More Than Double Your Retirement Funds ... Minimize Intermediation Costs to Maximize Individual Investment Returns ... Money Spent on Intermediaries is Money Not Invested ... And It's Very Costly

Yesterday we discussed our nation's "fissiparousness" (having a tendency to divide into groups or factions).

The word to be discussed today is financial "intermediation" (investment through a financial institution, aka a 'go-between').

The stock market took a hit this past week. If it follows normal practice, it may continue to struggle next week and perhaps the rest of the month as well. But my guess is it will end the year substantially higher than it closed yesterday. Nevertheless, that's not a prediction, and I certainly claim no special expertise about the inner workings of the stock market, aka the market 'technicals.'

The 'fundamentals' of many individual companies, however, are a different story, and I believe the general stock market is not overvalued currently.

I especially find Intel (symbol INTC) interesting after it dropped 5% yesterday. The company is a blue chipper, pays a 2.8% dividend and carries a PE ratio of 15. Several dividend paying banks {such as Wells Fargo (WFC), JP Morgan (JPM) and US Bancorp (USB)} are also interesting, and even oil company Exxon (XOM), which now pays a dividend of 3% and has a PE of less than 12, looks pretty good to me as a long term buy. Then there are other attractive candidates such as the shares of Boeing (BA), GE, Wal-Mart (WMT), Whirlpool (WHR) and world leading pharmaceuticals like Pfizer (PFE) and Merck (MRK). But I digress.

In any event, the shares of those kinds of blue chip companies are definitely on my soon-to-buy shopping list, and I own shares of all of those mentioned above. Although I haven't decided when to jump back in, when "good stuff" is offered at sale prices, it's always time well spent to be an attentive looker. And so I am.


Chad's post yesterday concerned math. So let's discuss some simple math as it applies to individual investing today --- the value associated with minimizing and optimizing intermediation costs in order to maximize long term investment returns on our own money, which I refer to as MOM (my own money), in preference to maximizing the intermediary's OPM (other people's money) based earnings over the long haul.

Human nature suggests that the informed individual is or should be MOM focused, whereas the intermediary will be very much driven by getting more of OPM, aka what could remain the individual investor's MOM. Let's do the math.

The simple math compounding 'rule of 72' means that a doubling of money occurs anytime that the multiplication of two numbers representing (1) length of time invested and (2) average annual returns on funds invested during that time equal 72. Eight years at 9% equals a double, as does tweleve years at 6%. Nine years at 8% and eight years at 9% equal a double as well. And so forth.

Accordingly, the greater number of years money is invested at any given average annual return, the more doubles occur. And the higher the average annual rate of return for any given number of years invested, the more doubles occur. Thus, the simple idea underlying successful long term individual investing is more years invested at higher annual rates of return.

And if you do your own math, you'll notice that that last double can be a biggie. Accordingly, the success formula combines starting to save and invest early and then owning blue chip stocks for the duration, periodic tweaking aside.

It's very much a case of long term DIY investing on the cheap. And that's where our word of the day comes into play.

Intermediation costs are just what they appear to be -- money paid to financial intermediaries to complete transactions --- such as real estate brokerage fees, commissions charged and so forth.

In stocks intermediation costs represent the fees and charges from brokers, mutual fund loads, aka commissions, and other charges by so-called experts.

John Bogle is the founder of Vanguard Funds and a dedicated advocate of low cost index fund investing. He explains his simple approach with simple math in Bogle's 'scary-math' shows up in retirement balances:

"John Bogle, founder of the Vanguard Group, recently explained the unavoidable mathematical reason why passive wins over active in retirement investing: You keep more of your own money invested, and it compounds in your favor, not Wall Street's.

Fees paid to active managers end up equaling a huge amount of lost return, up to 80% of your gains over a lifetime, Bogle said. Don't believe it? You ignore such "humble arithmetic" at great risk....

. . . the amount saved should be higher than the dollars set aside plus the compounding market return — much higher — and it just isn't. The typical worker saving diligently since 1982 should have had $373,000 in a qualified plan by age 60. Instead, that saver has $100,000 . . . .

An awful deal

Where did the money go, and what can you do to avoid being that person? Clearly, you can avoid borrowing against your own savings. And you can make sure to contribute steadily and to the maximum possible, especially in the early years to give compounding a chance to help you along. More time equals more money.

And, as Bogle explains, you can dramatically cut Wall Street's take by using index funds....

The reason is compounding: Invest a dollar in the markets and you stand a chance to earn, charitably, 7% on your money. But the manager is taking 2% of your total plan balance of $1.07. So while you might make 7 cents on the dollar, the adviser is sucking in a bit more than 2.1 cents. In reality, that 2.1 cents is more than 30% of your one-year gain of 7 cents.

That giant sucking sound continues as your balance grows. Imagine instead of $1 you have $100,000 in your IRA in your 40s. You should be well on your way to retirement with that kind of balance, assuming you have a decade or two of earning years left.


Yet the active manager is still charging 2%. If you do earn a nice 7% on your pot, you pull in $7,000. Yet you're giving $2,140 to the manager. That's right, you are still losing nearly a third of your money to Wall Street.

All along the way, it must be assumed, the manager is earning a compounding return on your money, money that he or she keeps and will never share with you.

As that money compounds outside of your plan it overwhelms your results. Over the long haul the amount of your potential return lost to Wall Street is more like 65% and rapidly heading higher.

In short, every dollar you give away to active managers is gone forever and compounding for someone else. Retiring with more means you have to plug that gap by lowering fees, as soon as possible and permanently."

Summing Up

The understanding of simple math yields real and useful knowledge.

The compounding of money that is invested over a lengthy period of time will multiply several times in adulthood. That's due to the simple and easy to use mathematical rule of 72.

Most important, a broker's or mutual fund's intermediation costs can easily result in two thirds or less earned on our investments taken from us over a working career. That's a real genuine biggie!

These all too often occurring results are staggering, needless and often completely misunderstood by individual investors.

As a consequence, the individual's family suffers in a really big way while the intermediary profits.

Don't let that happen to you. Instead let your actions be dictated by letting the rule of 72 work for you in a big way.

It's a simple case of simply applying the rules of simple math. 

Thanks. Bob.

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