5. Andrew Tobias, The Only Investment Guide You’ll Ever Need (Orlando, FL: Harcourt, 2002), 185.
6. Andrew Tobias in an e-mail to the author, February 6, 2006.
7. Late in the roaring decade of the 1990s, an older friend of mine used to brag continuously that his broker was putting him in “high-quality preferreds.” He would go on and on about the joys and value of high-quality preferreds. I often wondered to myself what “high-quality” meant in this context, but I didn’t want to ask him. I assumed that this referred to the preferred stock of more established and less speculative companies. After all, preferred stock and convertible bonds are often used to raise capital for weak or very speculative companies. After the first few years of the twenty-first century, with its sharp stock market fall, I never heard another word from him about high-quality preferreds—or anything else about his investments. Later, though, a mutual friend told me that a significant number of those high-quality preferreds were issued by Enron.
8. Alas, few of us still have local butchers who own their own shops. On the other hand, such a butcher-businessman invariably was aware that his customers lived down the street and would be in to see him next week. This is in sharp contrast to the investment firm peddling hybrid securities that is unconcerned with its interaction with the retail customer.
Chapter 35
How Much Is at Stake?
The amount of money that is at stake for an individual investor is startling. By learning how to negotiate your investments effectively, including a strong knowledge of the economic truths in Part III of this book, you can put a remarkable amount of money into your own pockets. By the same token, the failure to pay attention, learn what economists can prove, and advocate effectively for your own interests will actually cost you a fortune over time.
Some years ago, I turned to one of my brightest Wharton students and said, “Make me a chart that shows exactly how much is being gained for any amount of additional return or reduced costs.” (Their effect on your bottom line is the same.) He asked me to state a compounding rate or, to put it simply, a realistic estimate of how much the money would grow each year. Some basic research suggested 7 percent, so that is the return rate I asked him to use. Table 35.1 is what he came up with.
Table 35.1 Percentage of Savings and Resulting Increases in Portfolio Holdings, Starting with $1,000,000
Number of Years Invested
% Savings 1 5 10 15 20 25 30
0.10% $1,000 $6,554 $18,385 $38,678 $72,331 $126,812 $213,434
0.20% $2,000 $13,108 $36,770 $77,358 $144,668 $253,639 $426,906
0.30% $3,000 $19,662 $55,155 $116,041 $217,016 $380,496 $640,453
0.40% $4,000 $26,216 $73,541 $154,728 $289,380 $507,400 $854,115
0.50% $5,000 $32,770 $91,929 $193,422 $361,765 $634,364 $1,067,927
0.60% $6,000 $39,324 $110,318 $232,123 $434,178 $761,405 $1,281,929
0.70% $7,000 $45,879 $128,709 $270,834 $506,623 $888,538 $1,496,158
0.80% $8,000 $52,433 $147,101 $309,555 $579,105 $1,015,778 $1,710,652
0.90% $9,000 $58,988 $165,496 $348,289 $651,631 $1,143,140 $1,925,450
1.00% $10,000 $65,543 $183,894 $387,036 $724,206 $1,270,641 $2,140,589
1.50% $15,000 $98,319 $275,931 $581,035 $1,087,999 $1,910,745 $3,222,739
2.00% $20,000 $131,102 $368,077 $775,611 $1,453,822 $2,556,604 $4,319,166
2.50% $25,000 $163,894 $460,368 $970,957 $1,822,356 $3,210,159 $5,434,714
3.00% $30,000 $196,697 $552,839 $1,167,266 $2,194,289 $3,873,370 $6,574,300
3.50% $35,000 $229,512 $645,527 $1,364,734 $2,570,309 $4,548,221 $7,742,934
4.00% $40,000 $262,342 $738,469 $1,563,554 $2,951,113 $5,236,726 $8,945,736
4.50% $45,000 $295,190 $831,701 $1,763,924 $3,337,406 $5,940,933 $10,187,956
5.00% $50,000 $328,057 $925,258 $1,966,039 $3,729,898 $6,662,929 $11,474,995
aAssumes 7 percent average annual rate of return, so 1 percent savings is the difference between 7.5 and 6.5 percent.
Table 35.1 is not hard to read. It starts with a $1 million portfolio. Running down the first column is the amount (expressed in percentages) that return is increased. (Or that costs are decreased. The effects are exactly the same.) The columns to the right of that show the resulting increases in portfolio value over a number of different time periods. Thus, if you go down to 2.00 percent (2 percent per year) and read across, you will see that at the end of 30 years, you would have $4,319,166 more than if you had lost out on 2 percent per year. It is a remarkable fact of compounding that this number is more than four times greater than the amount you started with.
It is sometimes argued that these numbers will be accurate only if all money saved is immediately reinvested. That is true. I would point out, though, that in the case of a retirement plan such as a 401(k), it is surely the case that the money would indeed remain invested in the plan. Virtually nobody who noticed that their retirement plan was earning 2 percent more than expected would react by trying to pull money out. Remember, the law strongly incentivizes retirement savers to keep that money in. So at least in the case of retirement plans, it is safe to say that a penny earned is going to multiply as shown in this chart.
The Impact of the Fees You Pay for Advice
How is that possible, you may wonder, that so much money is at stake? Let’s consider the fees you pay for investment and financial services. The services you are actually receiving may well be costing an amount far in excess of what is fair. For example, consider Sarah who asked us to estimate the overall costs and fees she paid to the advisory company she had previously worked with. Although some of those costs were deeply hidden, we were able to conclude that those services had been costing her a total of approximately 4.6 percent of her investment assets each year. Let’s suppose that a fair fee for those services might have been 1.25 percent per year. She was losing out on 3.35 percent per year. It is fairly simple math to see that her $1 million portfolio was growing by $33,500 less each year than would be the case if she paid only a fair fee. Even in the short term, the difference in portfolio value as a result of higher fees is striking.
That sounds like a lot of money, but the long-term numbers get much more dramatic. That money would have been reinvested in her portfolio and remained there for 30 more years. Let’s assume the overall return on her investments would be 7 percent per year except for the 3.35 percent of excessive fees. To see how much money she lost out on, we must calculate the return at 7 percent and then recalculate at 3.65 percent and compare the two totals. Once the calculation is completed, we see that her cost of doing business with those folks for 30 years would be more than $3.5 million.
Jack Bogle, the founder of the Vanguard Group and a noted critic of the financial services industry, estimates the cost of financial intermediation—that is, fees that financial middlemen charge—for the average family is 2.4 percent per year.1 Over the course of a lifetime, that amounts to a fortune lost.
Saving 1 percent per year on a $1 million portfolio will net you $2,140,589 after 30 years. Saving 2 percent on that same portfolio over the course of 30 years, you would have $4,319,166. Due to compounding, or interest generating even more interest earned, a small change in your investment performance can yield millions of dollars more in your lifetime.
If these numbers are too rich for you, consider the chart in Table 35.2. It is exactly the same as Table 35.1 but with $100,000 as the starting point instead of $1 million. Here, the effect of saving 1 percent (or increasing earnings by that much) each year brings you over $214,000 over 30 years.
Table 35.2 Percentage of Savings and Resulting Increases in Portfolio Holdings, Starting with $100,000a
Number of Years Invested
% Savings 1 5 10 15 20 25 30
0.10% $100.00 $655.40 $1,838.46 $3,867.83 $7,233.15 $12,681.17 $21,343.40
0.20% $200.00 $1,310.80 $3,676.96 $7,735.81 $14,466.83 $25,363.87 $42,690.59
0.30% $300.00 $1,966.20 $5,515.51 $11,604.10 $21,701.60 $3
8,049.63 $64,045.34
0.40% $400.00 $2,621.61 $7,354.15 $15,472.84 $28,937.98 $50,739.97 $85,411.45
0.50% $500.00 $3,277.03 $9,192.90 $19,342.21 $36,176.53 $63,436.43 $106,792.71
0.60% $600.00 $3,932.45 $11,031.80 $23,212.34 $43,417.78 $76,140.54 $128,192.90
0.70% $700.00 $4,587.88 $12,870.87 $27,083.40 $50,662.27 $88,853.82 $149,615.81
0.80% $800.00 $5,243.33 $14,710.14 $30,955.53 $57,910.54 $101,577.81 $171,065.25
0.90% $900.00 $5,898.79 $16,549.64 $34,828.89 $65,163.14 $114,314.04 $192,545.01
1.00% $1,000.00 $6,554.27 $18,389.41 $38,703.63 $72,420.60 $127,064.05 $214,058.90
1.50% $1,500.00 $9,831.94 $27,593.15 $58,103.51 $108,799.87 $191,074.51 $322,273.88
2.00% $2,000.00 $13,110.25 $36,807.73 $77,561.09 $145,382.17 $255,660.45 $431,916.57
2.50% $2,500.00 $16,389.42 $46,036.77 $97,095.68 $182,235.65 $321,015.94 $543,471.38
3.00% $3,000.00 $19,669.67 $55,283.90 $116,726.64 $219,428.86 $387,337.00 $657,430.04
3.50% $3,500.00 $22,951.20 $64,552.73 $136,473.38 $257,030.86 $454,822.09 $774,293.44
4.00% $4,000.00 $26,234.24 $73,846.90 $156,355.43 $295,111.31 $523,672.57 $894,573.61
4.50% $4,500.00 $29,518.99 $83,170.05 $176,392.38 $333,740.56 $594,093.27 $1,018,795.59
5.00% $5,000.00 $32,805.68 $92,525.82 $196,603.95 $372,989.81 $666,292.92 $1,147,499.46
aAssumes 7 percent average annual rate of return, so 1 percent savings is the difference between 7.5 and 6.5 percent.
The point I am making is obvious. In light of the effects of compounding, what might sound like a relatively small amount of money is actually huge over a significant length of time.
The Need for Action
This is the big message of this entire book. The amount at stake is far too great to ignore. As a teacher and writer, my greatest fear is that you will see that everything in this book is true and yet, somehow, conclude that these things are not too important. As this chapter demonstrates, though, the numbers are huge. The material in this book is what lies between you and a significantly better financial life. It is very important, and it deserves your attention today.
For most families, this information is worth several million dollars. That may seem exaggerated, but consider carefully. In addition to savings, most American families are depending on a retirement plan that requires making savvy investment decisions. We have moved from the old system of defined-benefit plans to a new world of defined-contribution plans. You get help from your employer and Uncle Sam with putting money in but, as far as making choices about how to invest the funds, you are pretty much on your own. Saving for college is, at least partially, moving in the same direction. Other parts of your financial life, such as insurance, also depend on your skill at understanding and holding your own in this complex financial system.
This is all to say that understanding the economics that underlie your investments, learning to be a strong negotiator when you invest, and avoiding being taken advantage of are far more important than you might have thought. The information in this book could be the most valuable contribution to your financial life that you have ever made.
Chapter Summary
A great deal is at stake—perhaps several million dollars.
Saving or negotiating even a 1 percent improvement in the performance of your investments can result in vast amounts of extra money over your lifetime.
Get started now. Do not wait. Make the changes suggested so that the compounding of extra money can begin in your accounts.
Note
1. John Wasik, “Bogle’s Blueprint for Enlightened Investing,” Chicago Tribune, August 20, 2012.
Afterword: What Is a Good Outcome in Your Financial Life?
As we draw toward closing, we return to the beginning. This book started out asking you to think about a good outcome: how it is defined and what it might mean to you in a particular situation. Figuring this out is essential to real success in any negotiation. What do you really want? At the end of the first chapter, I suggested the answer might include that which increases your happiness, fulfillment, pleasure, achievement, delight, contentment, and peace. It is a good answer, but it is not your answer. The definition of a good outcome is utterly subjective. It has got to be your good outcome if it is to be of real use.
Part I proceeded to explore how the best negotiators go about thinking, preparing, and doing. The elements of a negotiation were identified and the phases explored. While the exact pattern of any given negotiation is unique, the general way surely is not. The teachers and practitioners who have come before us left a rather well-worn path that we can follow. My hope is that the first part of this book can stand alone as a guide to becoming a better negotiator.
Part II showed you that investing is merely another type of negotiation. The methods, concepts, and tools of the negotiator can be used to improve your investment results. Once again, you should start by determining what a good outcome looks like and work toward that goal. As with negotiating generally, investment negotiations typically follow recognizable patterns. The difficulties, problems, and crooked places have been highlighted by those who preceded you. Part II explored some particular challenges facing you as an investor-negotiator. Thereafter, it examined the elements and phases with special emphasis on negotiating with investment advisors and financial intermediaries. Ultimately, the second part of this book was designed to help you get better outcomes when you invest.
Throughout, I urged you to pursue the negotiation process with diligence. Your success will be increased by doing your homework. In particular, improved outcomes are a product of preparation, exploration, thought, and discipline. A good negotiator learns the jargon, practices, and beliefs of those on the other side of the table and, when applicable, the arguments, rationalizations, and deceptions they may employ. So too, increasing subject matter knowledge and expertise will greatly advance your efforts.
If there is science, data, scholarship, or common sense to be mastered, it will serve you well to become totally familiar with them. In other words, the pursuit of a good outcome requires learning all that you can and using that knowledge in the negotiation process.
With that in mind, understanding and using economic facts is essential. There is great value in mastering the basics of what economists know; both to negotiate skillfully and to avoid being taken advantage of. Part III of this book considered some of the economic truths that will help to level the playing field. Among those is the extraordinary amount of money involved over the course of your lifetime.
In general, this book did not shy away from making opinionated suggestions concerning what might constitute a good outcome regarding your investments. Nor did it hesitate to preach about things to avoid, dangers to beware of, and bad outcomes generally. A great many of my own thoughts were offered up for your consideration.
In the end, though, it is not for me to define good investment outcomes. That job belongs to you. As this book has urged, you should be pondering it from the very beginning. It should remain a focus point throughout your negotiation. You should even keep it in mind when the entire process would seem to have reached its conclusion. All the while, you are adjusting and refining it, fending off developments that may interfere with it, and seeking to improve it by identifying an even better outcome. Can you come up with a more essential answer to the question, “What are you really trying to accomplish?” Your ability to name, envision, and work toward that good outcome will be the greatest factor in your success. At the end of the day, it is the most vital part of the task that lies before you.
It is my hope that the preceding pages gave you all the tools and guidance you need to turn your good outcome from idea to reality. I am confident that achieving it will greatly enrich your life. I wrote this book based on that belief. If I am right, and have done a good job guiding you, the result will be a big improvement in your financial circumstances. My fondest desire is that this work contributes to your greater well-b
eing. If that turns out to be true, I will consider it a very good outcome indeed.
Selected Bibliography
Axelrod, Robert M. The Evolution of Cooperation. New York: Basic Books, 1984.
Beer, Jennifer E., and Eileen Stief. The Mediator’s Handbook. Rev. and expanded 4th ed. Gabriola Island, BC: New Society Publishers, 1997.
Benton, Alan A., Harold H. Kelley, and Barry Liebling. “Effects of Extremity of Offers and Concession Rate on the Outcomes of Bargaining.” Journal of Personality and Social Psychology 24, no. 1 (October 1972): 73–83.
Bogle, John C. Bogle on Mutual Funds: New Perspectives for the Intelligent Investor. Burr Ridge, IL: Irwin Professional Publishing, 1994.
Bogle, John C. Character Counts: The Creation and Building of the Vanguard Group. New York: McGraw-Hill, 2002.
Bogle, John C. The Battle for the Soul of Capitalism. New Haven, CT: Yale University Press, 2005.
Burrough, Bryan, and John Helyar. Barbarians at the Gate: The Fall of RJR Nabisco. New York: Harper & Row, 1990.
Cialdini, Robert B. Influence: The Psychology of Persuasion. New York: HarperBusiness, 2006.
Diamond, Stuart. Getting More: How to Negotiate to Achieve Your Goals in the Real World. New York: Crown Business, 2010.
Dimensional Fund Advisors. Matrix Book 2013. Austin, TX: Dimensional Fund Advisors, 2012.
Ellis, Charles D. Winning the Loser’s Game: Timeless Strategies for Successful Investing. New York: McGraw-Hill Education, 2013.
Fama, Eugene. “Efficient Capital Markets: A Review of Theory and Empirical Work.” Journal of Finance 25, no. 2 (May 1970): 383–417.
Fisher, Roger, Elizabeth Kopelman Borgwardt, and Andrea Kupfer Schneider. Beyond Machiavelli: Tools for Coping with Conflict. Cambridge, MA: Harvard University Press, 1994.
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