Often on this blog I will talk about saving money in everyday expenses. From cutting your cell phone or cable bill to clipping coupons or the virtues of budgeting. All of these topics are important and there’s plenty of material to discuss but the fact is, most of the expenses we will face in our lives will come from only a few categories. They makeup what I call our major expenses and I think too often we ignore them. Ignoring them however could have grave consequences on our ability to save and leave the lasting legacy that we want to leave.
Four types of expenses immediately came to my mind when thinking about this article but there could easily be more. If you have another category in mind please mention it in the comments below but the four types I’ve singled out are college, home, vehicle and investment fees. Let’s discuss each of these in further detail.
As college expenses have skyrocketed over the last few decades the choice of where to go to college and what to study has become more important than ever. If you’re sitting there with the choice of going to a local community college because it enables you to pay off your bills as you go versus going to a more expensive university where your debt at graduation might be 20,000, 50,000 or even 100,000, the wise financial decision is obvious.
Let’s say your ready to begin college in the fall of 2017 and your planned graduation year is 2021. In those 4 years you were able to pay all but $20,000 of your college expenses. You took out student loans at a 5% interest rate and you plan on paying the loans back over a standard 10 year period. In those 10 years your monthly payment would be $212.13 and your total amount paid at the end of the decade would be approximately $25,455 for those student loans. This is a perfect example of interest working against you. I talk about compound interest a lot on this blog and how wonderful of a thing it is. The problem comes when it starts to work against you.
I believe it is also important to discuss what you will be studying. Colleges have dozens of majors to choose from and many of them have little if any actual job prospects. Yes, you might be passionate about that given subject but if you’ll never be able to get a job in that particular field why are you taking on debt to pursue that degree? It would be much wiser to at a minimum add on a second major in an in demand field such as nursing, business, engineering or IT. Otherwise going to college might not be a blessing but instead turn into a curse.
We are told all of our lives that one of the things we have to do in order to obtain the American dream is to someday own a home. That is all well and good and there is nothing wrong with owning a home but please remember that buying a home will be one of the most expensive single purchases you’ll ever make. I think the best example I can give is the purchase of $150,000 house. For this example the loan has a 30 year fixed rate of 5%. Would you believe the interest alone over that 30 years is just shy of $140,000. That $150,000 house has become nearly double the original asking price in just 30 years.
Of course you could always take out a 15 year loan or add in a large down payment which would defiantly reduce the interest you owe. But the fact of the matter is this is a major purchase and there are a lot of expenses involved that we don’t normally think about.
The other expenses include HOA dues, property taxes, insurance, maintenance expenses and the dreaded PMI for having a low down payment on your loan. Buying a home requires you to step back and view the decision logically.
Have you ever heard the phrase driving yourself to the poorhouse? Vehicles have become a necessity in our world but they can bring a lot of financial headaches into our lives if we aren’t careful. For example always buying new over buying used. You could save tens of thousands of dollars in your lifetime if you only chose to buy used.
There is also the decision of paying cash versus taking out a loan. If you have the cash to pay for a cheaper used car, why would you ever take out a loan to buy a more expensive new car? Financial decisions like this have never made sense to me.
This is one major cost that you might not have thought about but it can add up to massive sum of money over time. For example, lets say your goal is to save $1 million dollars in a retirement account. That amount is a popular number to shoot for and it is easy to do calculations on. If the average fee for the funds and any other services such as advisory fees comes out to 0.5% you’ll pay $5,000 per year in fees. When you look at the fee percentage it seems small enough but it can quickly add up over time.
Also, you have to remember this is only the face value cost. Over many decades, these fees will also have a massive impact on your overall rate of return. If you compound the return of 10% versus the return of 9.5% due to a 0.5% fee, the second portfolio will yield much less over several decades. This is a less obvious cost but it is one that is important to remember.
It is an astonishing thought but in your lifetime you could easily rack up a six figure sum of investment fees and reduced rate of returns. These fees come in many shapes and sizes ranging from administrative, fund management, robo adviser service costs or simply having a traditional investment adviser. Wherever the costs might be coming from, they might not appear to be significant but they are and they shouldn’t be ignored.
Now I’m not recommending passive funds over active funds. Nor am I saying that you shouldn’t seek help whether from a traditional advisory or a robo advisory service. Nor am I saying you should steer clear of new fintech creations such as Acorns or Digit. Your financial decisions are just that, your financial decisions. You are the only one who can decide what help you need and which products and services are best for you. All I want to do is point out that fees of any kind should never be ignored. The burden of these fess on your portfolio should never be underestimated.
Just as fees shouldn’t be your only factor when making investment decisions, it should also never be a factor that is completely left out. Your investments will always face three uphill battles, fees, taxes and inflation. You have very little control over inflation or the ever changing tax laws but you do have control over your investment fees. This is a simply a plea to make sure you focus on what you can control.
Like I said above, there are probably other categories of major expense out there but these are the four that came to my mind. Remember, no matter how many cups of coffee you skip, the savings will never eclipse the impact of only a few major expenses in your life. Our focus should always be on the big things first and then focus on the smaller items second. The smaller items won’t cripple us if we mess up here and there but messing up major purchasing decisions can have a lasting impact on our finances.