While perusing the usual periodicals, I came across an interesting article. It was fairly decent. It was in a well-known publication. Normally I’d give you the citation, but, if you read this missive to the end, you’ll think the author might thank me for not calling his name.
The story ends with this sentence: “Expenses, contributions and performance all contribute to long-term returns. And all else being equal, low fees get you to retirement quicker.”
I shook my head in a double-take and re-read the closing. I couldn’t believe it. The statement had all the logic bearing of a mind-numbed partisan proclamation.
Take a close look at the structure of this supposed syllogism. The author states three components influence long-term returns. OK, I can understand that. But then there’s the “all else being equal” qualifier leading to the conclusion that changing only one – fees – will lead to better long-term returns. This is the same tired argument made every day by lazy commentators. I can forgive a single miscalculation, but I must indict the multitude.
Quite simply, this represents more than a lack of rhetorical skill, it’s really bad math.
Let’s break this down in mathematical terms. It’s quite clear, of course, all things being equal changing any one of the three contributors more favorably will get you to retirement quicker. Why does it have to be just fees? Why can’t we focus instead on performance?
“Because past performance cannot guarantee future results” I hear the masses cry. True. But irrelevant. Logic requires one to see how, keeping fees and contributions the same, better performance must lead to better long-term returns.
Hmm, wait a minute here. Aren’t “long-term returns” just another way of saying “performance” anyway?
Whoops. It we want to rid ourselves of this circular logic, we must say “expenses, contributions and performance all contribute to ‘getting you to retirement quicker.’” Then it makes sense to say “all things being equal, better performance will get you to retirement quicker.” There. We can all agree on that.
Now let’s try keeping performance and fees equal but increase contributions. Certainly it goes without saying this will get you to retirement quicker. I don’t see how anyone can disagree with that. In fact, most sober practitioners will tell you this is the most critical and underappreciated fact in the entire 401k universe.
Which leads us to our third mathematical combination. If we keep contributions and performance the same will lower fees really get you to retirement quicker? This depends on what the meaning of “fees” is. As we’ve said before, some fees matter and some fees don’t matter. If, like the usual suspects, you classify a fund’s expense ratio as “fees” then, guess what? You may find yourself in a losing battle against Mr. Spock.
Why? Because those “fees” are already incorporated in performance. Look at it this way. If performance is equal – one of our necessary assumptions – than, whatever the fees are, the performance is the same. In this definition of fees, it doesn’t really matter if they’re high or low because your demarcated precondition requires the performance to remain the same despite the fund’s expense ratio.