Where many people go wrong
When signing up for a retirement plan at work and faced with a 1% expense ratio (ER) versus a 0.1% ER, many people think who cares? A difference of 0.9%, big deal. For every $1, I only give up 0.9% or 0.9 pennies. No reason to sweat the difference. But if your retirement plan has 1% expense you won’t just lose 1% of the total amount of your portfolio to expenses, you’ll lose 1% per year. That’s the key, your losses COMPOUND, and humans aren’t good at comprehending the effects of compounding.
Great, show me how I save $57,000
Frank FIRE has a 15 year plan to get FI. He defines FI has having 1 million in today’s dollars that allows a 3.5% safe withdrawal rate of $35,000. He is going to save and invest between 25% and 65% of his salary. For the first 5 years of this plan he will live on 30k/year. For years 6-10 he will live on 35k and in years 11-15 he will splurge and live on 40k. His salary will start at 40k and grow to 110k over this period. In Frank’s profession salaries top out around 110k so as he gets closer to this number his raises will slow down. Early in his career once he is established he expects rapid raises. Frank of course takes advantage of his 401k and he has two choices. A managed all-in-one fund for a 1% fee, or he can use a Bogleheads Three fund Portfolio approach with index funds and get his costs down to 0.1%. He will use a conservative approach, 50% stocks and 50% bonds which has yielded a historical return of 8.3% between 1926 and 2016. Frank decides to determine what the expected costs is using Vanguards cost tool. He uses a 6% expected return which allows him 2.3% lost to inflation (8.3-6=2.3%). He runs the numbers and realizes he will save $57,000:
This is a conservative estimate
This assumes the money is put in the account on the last day of the year so in year 1 you only have 14 years to compound, not 15. In reality Frank would contribute throughout the year. So he would save more. Also if your FIRE path is 20 or 30 years the savings will be much larger due to a longer compounding period.
Who can save that much?
You have to be motivated. But there are people who spend less than 40k on a family of five and still have a lot of fun, so 30-40k is not unreasonable for Frank.
But I work for a non-profit and will never make more than 50k
In that case you can look at Frank FIRE’s numbers as a goal for two people instead of one.
But what if the managed fund does better than the Three Fund Portfolio?
Odds are it won’t. Only 17% of actively managed funds beat a Three Fund portfolio over a 16 year period, more here.
OMG I own a fund in my 401k that has a 0.75% ER
I used to have one with a 0.86% ER, don’t feel too bad.