We'll teach you how.
“An expense ratio is the amount companies charge investors to manage a mutual fund or exchange-traded fund (ETF). The expense ratio represents all of the management fees and operating costs of the fund. The expense ratio is calculated by dividing a mutual fund’s operating expenses by the average total dollar value for all the assets within the fund.” Investopedia
About 8 years ago, I was put on the first retirement plan committee at my day job. Until that point, my employer had a pretty generous 401(k) with a match. But there was nobody regularly monitoring the 401(k), its funds, or the fees charged by the broker, the plan administrator, and the individual funds in the plan.
There were two of us on the committee–the controller and myself–that became obsessed with lowering the expense ratio. For those of you who aren’t familiar with expense ratios, they are the fees you pay to maintain your 401(k), expressed in terms of a percentage. When the committee took over management of the 401(k), the average expense ratio of the funds in the plan was 3.5%.
That meant that for every $100 that someone had in the 401(k), they had to spend $3.50 per year. $1,000.00 meant that they had to spend $35.00 a year. $100,000 meant $3,500. You may be looking at those numbers and thinking “What’s the big deal? $3.50 per year is nothing. Seems like you’re chasing pennies.”
Here’s the deal, though. An average return in a well-balanced 401(k) might be 6% to 8% per year. As a matter of fact, that’s the percentage you’ll often see as the assumed return in a retirement calculator. And over the life of a retirement plan, for every year that you have a 20% return (“hello, 2012”), most years are much lower (“hello, 2008”). Thus, planners don’t like to count on more than 6% or 8% (game theory regression to the mean?).
Let’s do a little bit more math. That means in an average year, $100 in your 401(k) will earn you between $6.00 and $8.00. That sounds pretty good…..until you subtract the expense ratio. If you put $100 in the plan and it earns 6%, at the end of the year you have $106. But then you have to subtract the expense ratio ($106*.035) and you are left with only $102.29. Now let’s suppose inflation is 3%, which is what the Federal Reserve targets as ideal inflation. That means the $100 you invested is actually worth less than when you invested it. What a total rip-off. More than half of your investment gain went to money managers and brokers.
There are entire blogs dedicated to lowering expense ratios. Financial independence retire early (FIRE) folks lose sleep over them. No one wants to give away the money they earn on their investments. For five years, the retirement committee at my day job negotiated and re-negotiated the fees our 401(k) participants were paying. Every time we spoke to our plan broker, we asked for lower rates. Eventually, through negotiation, we were able to get the average expense ratio on the 401(k) down to between 1.25% and 1.5%, which put our plan in the 99th percentile for plans its size.
So right now, you are probably asking yourself why I just wrote 500 words on 401(k) expense ratios in a blog about buying and selling houses. Well, the answer is easy. For most people, their home is their largest investment. And while I don’t personally think you should plan on retiring based on your home’s equity, when you start to prepare to sell your home you should think of it like an investment.
Historically, home prices have been tied directly to inflation. While in some locations during some time periods, home prices outpace inflation (like Boise over the last couple of years), and others lag behind (say maybe Detroit), eventually, given a long enough time, house prices will be pretty even with inflation. That means if your home was worth $200,000 when you bought it, after 10 years at the average inflation of 3% it would be worth $268,780.00. An extra $68,780 in equity sounds pretty good, doesn’t it?
Here’s the thing though: your home may have appreciated 68,780, but that appreciation wasn’t cost-free. If you’re like most Americans, you needed a mortgage to buy your house. No shame in that; not very many people have $200,000 in cash lying around. For this real estate thought experiment, let’s assume that you have a standard 30 year mortgage, and that you put 20% down. Rates have been historically low for the last decade, so let’s give this mortgage a relatively modest 4.0% interest rate. That means in 10 years, you will have paid $58,138.25 in interest. You have only $10,641.75 in gain left after your interest payments. Ouch!
Now, here’s where this math stuff starts to really get scary if you aren’t paying attention. If you pay a realtor or real estate agent the standard 6% commission to sell your house, you will be paying $16,126.80. That means if you sell your house, you’ll actually be getting $5,485.05 less for your house than you paid for it! After 10 years! Now you still will get a check when you close, because you’ve also been paying down your mortgage during that time. But, your house, as an investment, has been a loser. It has a negative rate of return.
How do you make money on the investment that is your house? Well, on the transaction side of things you do exactly what the retirement committee did. You have to lower your expense ratio. You can do that in two ways. First, you can lower the amount of interest you pay on your house. In a few weeks we’ll interview a lender to give you some tips on exactly how to do that. But at most we are talking about ½% to 1% you might be able to save, and that is if your credit is bad or rates go down. And one thing to note about interest rates is that they are often pegged to other economic indicators, so there isn’t much room to negotiate. However, saving one percent is still worth it and you should totally make that effort.
But there is another way to save a whole lot of cash on a real estate transaction. Just two paragraphs ago we talked about the two major expenses in a real estate transaction: the interest rate and the real estate commissions. You can save 6% of the value of your home by selling it yourself. In the example above, if you didn’t use a realtor on your $200,000 house, it swings the transaction from being a $5,500 loss to almost an $11,000 gain. Hey, a gain is better than a loss any day of the week. What’s more, you’ll have a 5.32% return on investment. Not quite 6%, but pretty dang close, and a reasonable gain for an investment.
If you are worried about selling your house yourself, of maybe have never really thought about it, we are here to teach you how. Revostate’s tools and tutorials can help you turn your biggest investment into an investment that actually gives you a return instead of a loss.