My $1,169 Roth IRA Mistake

It’s not much fun to admit a mistake, especially when it cost me $1,169. If anything, sharing the story will hopefully help you avoid the same fate. You see, back in the late 90’s I put some money into a Roth IRA account holding mutual fund shares that focused on tech stocks –if you can believe it– because, yeah, it was the 90’s.

Quick reminder: a Roth Individual Retirement Arrangement is a retirement vehicle that allows individuals to invest non-deductible (taxed) income now in order to make qualified tax-free withdrawals at the age of 59.5 (subject to certain restrictions, see the IRS’ webpage for more info).

My investment faced some real headwinds with the tech bubble burst, the early 2000s recession and the 2008 global financial crisis all playing havoc with the basically nonexistent returns. After an extended lost decade my investment has finally made some small gains thanks to U.S. stock market performance since 2013.

SPX daily 5y

No one can control the market. Arguably, it would have been advantageous to time my investments better by going in and out of the market at various points or choosing the securities bought more carefully–though, to be fair, market timing is notoriously difficult even for professionals while also incurring greater transaction costs and pretty much every asset class or instrument available took a hit in 2008 leaving few, if any, safe havens.

In fact, my big mistake was paying excessive charges. On my initial investment of $3000, I paid $1,169 in fees and expenses that could have been completely avoided. Let’s do the math.

Account fee

I opened the Roth with a financial advisor which seemed like a good idea at the time since I was just finishing high school and knew next to nothing about finance or investing. The account was subject to a $40 annual maintenance fee for each of the 15 years for a total of $600. The advisor put the money into a mutual fund where, as it turns out, the same fund company would have only charged a $10 annual maintenance fee with a $10 one-time setup charge–which would only amount to $440 wasted except for the fact that many brokerage firms and asset managers offer no-fee Roth accounts. Amount wasted: $600.

Load

I ended up in a retail investor share class with a high front-end load of 5.75% on the $3000, or $172.50–most of which goes right into the fund management company’s pocket. There are circumstances where a front-end load may be appropriate when used by the fund company to cover upfront transaction costs of buying securities in certain markets. This was not one of those situations. In fact, the same firm offers a no-load advisor share class although my financial advisor, a full-service brokerage firm, did not opt for it. (The two share classes had nearly identical expense ratios, so all things being equal this was the poorer choice). Cumulative amount wasted: $772.50.

Mutual fund expenses

The asset management industry is highly competitive and the rise of passive index-tracking strategies has put further pressure on fees. By and large, investors are better off paying less in fees and expenses when possible. While mutual fund annual expense ratios vary anywhere from 0.08% to 2%, the average annual expense ratio for target-date funds (a set-it-and-forget-it one fund solution for many investors) is 0.84% according to Morningstar.

My financial advisor put my $3000 into a large cap growth fund that coincidentally charges 0.84%. However, having done my own research (because my advisor only showed interest in running transactions on my account and not providing advice–as described here) I found a diversified target risk growth fund of which I’m rather fond for only 0.18% or 18 basis points. Having instead invested the money in the less expensive fund would have generated cost savings of $301.50 based on a rough asset-weighted estimate of the cost differential (66 bps) over 15 years.

I’m not naming the funds here because it’s an apples-to-oranges comparison, and that would be unfair. Performance-wise, the large cap growth fund slightly outperformed the diversified target risk fund over 15 years, although the former is down -3.40% year-to-date while the latter is up 0.53%. Personally, I had to opt for the broader diversification that comes with a mixed stock & bond portfolio and international exposure. Cumulative amount wasted: $1,074.

Exit fees

If it’s not yet clear, I am decidedly underwhelmed with my soon-to-be ex-financial advisor which is why I moved into a no-fee Roth with my preferred asset manager. I’m not sure if the feeling was mutual because, lo and behold, the advisor had a parting gift for me: a $95 termination/distribution fee tacked onto the end of our relationship. Termination fees can range from $50 to several hundred dollars. The best way to avoid them is to pick a good provider and stick with them for the long haul. Total amount wasted: $1,169.

A pricey lesson

While my experience cannot be generalized, over the years researchers have noted that bringing financial advisors into your investment decision-making can reduce performance on both an absolute and risk-adjusted basis (lower returns and lower Sharpe ratios) while incurring higher costs. Essentially, the best way for many of us to get the most from our investments is to do the homework ourselves.

Leave a Reply