Janette accepts a job at an international school in China. She’s thrilled by the school’s retirement package. They match what she invests, up to an amount equaling 10 percent of her annual salary. In other words, if she were paid $50,000 per year and invested $5000, the school would pitch in an additional $5000. That’s a 100 percent annual gain.
Most international schools don’t offer savings incentives for faculty. Among those that do, few are generous enough to match contributions up to 10 percent of a teacher’s salary. But for Janette to earn the bonus, she has to use the financial firm selected by the school. There lies the problem.
I can hear what you’re thinking. “If a school offers to match 100 percent of what its teachers invest, why should Janette care what firm the school selects?” Unfortunately, it matters—a lot. High investment costs can cripple.
Let’s use Janette as an example. She should invest more than 10 percent of her salary. After all, while living overseas, she won’t be contributing to her home country’s social programs. Whether that’s Social Security (for Americans) or Canada Pension plan (for Canadians) she may not qualify for full future benefits.
Realizing this, Janette chooses to invest 20 percent of her income. Based on a $50,000 salary, that’s $10,000 a year. Her school matches investment deposits up to 10 percent of her annual income. So she’ll invest $15,000 per year for the price of $10,000.
So far so good.
But her school (and this is surprisingly common) chose an investment platform costing 3.5 percent per year. The financial advisors didn’t mention that. Investors are charged on at least two levels. Teachers pay administration or account management fees, plus mutual fund expenses.
Nobel economics prize winner, William F. Sharpe published an article called “The Arithmetic of Active Management.” In it, he proves that if the average U.S. stock earned 10 percent annually over a five-year period, the typical person paying 3.5 percent in investment fees would average 6.5 percent (10% - 3.5% fees = 6.5%).
You might think that paying 3.5 percent in investment fees isn’t a big deal—especially if your school provides a matching incentive. At first glance, this makes sense. But look closer.
Expatriates can build their own portfolios of index funds. And they could do so for 0.2 percent or less each year. What if Janette decides to say no to her school’s matching contribution? She invests on her own, using low cost index funds. Ironically, declining the matching contribution could put nearly $400,000 more into her pocket over 30 years. Note the two scenarios below:
|Investing With The School’s Platform, Including The Matching Incentive||Investing In Low Cost Indexes, Without A Matching Incentive|
Total Annual Amount Invested After Match
(Assuming school gives 100% match, up to 10% of Janette’s $50,000 salary)
|Assume Global Markets Average The Following Return||10%||10%|
|Annual Fees Paid On Total Portfolio Value||3.5%||0.2%|
|Annual Returns After Fees||6.5%||9.8%|
|Total Portfolio Value After 30 Years||$1,379,838||$1,739,129|
When selecting investment options, few school administrators realize how crushing costs can be. Firms that offer investment platforms costing 3.5 percent (or more) include Zurich International, Generali, Friends Provident, Aviva and Royal Skandia, among others.
Total fees are rarely disclosed. A financial advisor might say, “Our fees are just 1.5 percent per year.” But dig deeper. You’ll find another layer. Investment services firms, for example, don’t create their own mutual funds. So detectives looking for total costs must scrutinize two levels of fees: those charged by the financial services company and those charged by the mutual fund company.
Is there an easier way to discover if a firm is too expensive? Research I did for my book, The Global Expatriate’s Guide To Investing found you could start with a single question:
“Could I withdraw all of my money after one year, without paying a penalty?”
Expensive firms will say no. Some international schools are aligned with companies that would take up to 80 percent of an investor’s proceeds after such a withdrawal. Other firms wouldn’t allow an early withdrawal at all. They’ll want long term contracts to bleed you for years.
It’s a simple question. But it’s surprisingly effective as a litmus test.