By Scott Burns
Q. In a recent column you mentioned the importance of expense ratios when evaluating mutual funds. Although I look at the ratios, I also evaluate the funds’ performance. If the performance is higher, I may select a fund with the higher ratio. Don’t you think the net gain has warranted it? I would appreciate your input. —G.Z., by email from Austin, TX
A. It’s all about the odds and the game. Mutual fund expense ratios are similar to the house “vig” in a casino— the money taken by the casino. In a casino game the vig may be small, as in blackjack, or it may be large, as in slots. But the house always collects. The longer you play, the greater the odds that the house will have your money and you won’t.
The difference between a casino game and an investing “game” is that casino games are sum-zero games. No value is created, so every win is offset by a loss. Then the house vig makes it certain that more money will be lost than made by those who play the games. Put your money at risk often and it will be lost due to the drag of the house vig.
Investing games are positive-sum games. Value is created by the payment of interest, dividends, or (sometimes) stock price growth. So people can “leave the table” with more money than they had on arrival.
If they “play” at the expensive funds, however, their chances of asset growth are diminished, just as slots players are likely to lose more money than blackjack players. Why? Simple: The house vig on slots is bigger than the house vig on blackjack.
Wall Street hype notwithstanding, there is no evidence that paying high fees increases your return. There is much evidence that paying high fees reduces your return.
Many readers had difficulty finding the “Fat Fund Report” mentioned in that column. The report, which is free, shows the distribution of mutual fund fees by major fund category. It can be read online or downloaded as a PDF file from this URL: www.assetbuilder.com/fatfund .
Q. I am 55 years old and currently working— but looking to retire at 57. On my most recent statement from Social Security, my benefit at 62 would be about $1,500 a month. How much would that change if I quit working at 57? Lately the amount seems to increase quite a bit each year. Last year it was only $1,300. —G.F., by email
A. Your Social Security benefit is based on your 35 highest years of indexed wages. So each year you work will either add a year to your work record or, if you have worked over 35 years, it may displace a year of lower indexed earnings. As a result, each year of additional work can add nicely to your ultimate retirement benefit. This is particularly true at age 62 to 70 because you are rewarded further for delaying benefits.
Unless you have substantial savings and investments— or are seriously ill and not likely to live long— thinking about retiring very early is not wise. Most people should try to work to full retirement age (66) or longer.
This is not a terrible thing. If Social Security retirement benefits covered retirees for the same proportion of their lives today as they did when Social Security was created, the full retirement age would be something over 72.
The sorry reality is that Social Security benefits are the single largest source of income for the majority of retirees. According to a recent Congressional Research Service study of income and poverty among older Americans, for instance, 46 percent of Americans 65 and older had no income from investments in 2008. The 54 percent who did have investment income had a median investment income of $1,054 compared to their median Social Security benefit of $12,437.
The message is simple: We need to save and invest more, but we also need to pay attention getting the best benefit possible from Social Security.
On the web:
The Fat Fund Report
