Living in Retirement

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Investment costs in retirement: When less means more

May 17, 2013

Are you worried that you won't have enough money in retirement? You're certainly not alone.

When it comes to retirement planning, many of the most important factors are beyond anyone's control. Markets are unpredictable—ditto for the economy. Health care costs are sure to keep rising. And when it comes to exactly how long your money will need to last, well, that may be the greatest unknown of all.

But there's at least one thing you can control—and it has a major bearing on how long your savings will last.

How Vanguard stacks up

As of December 31, 2012, the average expense ratio for Vanguard mutual funds was 0.19%, while the industry average was 1.11%, according to independent fund rating agency Lipper Inc.

Learn more about how investment costs can erode your returns »

We're talking about investment costs.

All mutual funds deduct operating expenses from the market returns they pass on to their investors. The higher your expenses, the less money you get to keep. Whatever you pay in fund expenses eats away at how much you'll be able to spend in retirement.

On the surface, the difference between two funds' expenses can seem minor. Often it comes down to a few basis points—a mere fraction of a percentage. But those fractions add up over time, and your portfolio's overall expense ratio might have a significant effect on your standard of living in retirement.

Pay more, get more? Not necessarily

"Markets are unpredictable. Costs are forever," according to Vanguard's Principles for Investing Success, a new research paper detailing several of our core beliefs.

"The lower your costs, the greater your share of an investment's return," the paper's authors explained. "Minimizing cost is a critical part of every investor's tool kit. This is because in investing, there is no reason to assume that you get more if you pay more. Instead, every dollar paid for management fees or trading commissions is simply a dollar less earning potential return. The key point is that—unlike the markets—costs are largely controllable."

Let's say you retire with a mutual fund portfolio worth $300,000. Based on your health history and other factors, you estimate that this nest egg will need to generate income for 30 years. You favor a "moderate" investment mix, split evenly between stock funds and bond funds, with expense ratios averaging 1.25%. That means you'll pay $12.50 in investment costs each year for every $1,000 you've invested, or $3,750 in your first year of retirement.

But what if your average expense ratio was 0.25%? You'd pay just $2.50 per $1,000, or $750.

What might this mean over time? Although a one-percentage-point difference in expenses may seem trivial, a $3,000 cost difference—and remember, that's just one year's worth of expenses—is anything but. 

Would you turn down $45,000? 

Now look at that example from a slightly different angle.

We'll start with that same $300,000 and the same moderate stock/bond mix, but this time we'll base our assumptions on using mutual funds with an average expense ratio of 0.25%. To have a reasonable chance of making your portfolio last 30 years, our calculations suggest that you could potentially spend $11,400 (3.8% of your total savings) in the first year and then adjust your withdrawals for inflation each year after that.

But bump your funds' expense ratio back up to 1.25%, and your potential withdrawal in the first year of retirement drops to $9,900, or 3.3% of the total.

All else being equal, the low-cost portfolio would potentially give you significantly more money each year than the higher-cost portfolio, while still giving you a good chance of not running out of savings.

Still not convinced? Consider this: Over 30 years, the higher-cost portfolio could cost a retiree $45,000 more in spending power (in today's dollars) than the lower-cost portfolio, according to Vanguard's analysis.

This brings us back to our original question about having enough money in retirement. If the prospect of losing $45,000 to high investment costs doesn't trouble you, congratulations—you're probably one of a lucky few.

For the hypothetical examples cited above, the average expense ratio is 0.25% for the "low-cost portfolio" and 1.25% for the "high-cost portfolio." The estimated spending rates assume an 85% chance that the portfolio won't run out of money over a 30-year retirement. The projections or other information generated by the Vanguard Capital Markets Model (VCMM) regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. VCMM results will vary with each use and over time. See the footnote below for more information on the VCMM's assumptions and projections.

*The Vanguard Capital Markets Model (VCMM) is a proprietary financial simulation tool developed and maintained by Vanguard Investment Counseling & Research and the Investment Strategy Group. The VCMM uses a statistical analysis of historical data for interest rates, inflation, and other risk factors for global equities, fixed income, and commodity markets to generate forward-looking distributions of expected long-term returns. The asset return distributions shown in the research paper Revisiting the '4% spending rule' are drawn from 10,000 VCMM simulations based on market data and other information available as of December 31, 2011.

The VCMM is grounded in the empirical view that the returns of various asset classes reflect the compensation investors receive for bearing different types of systematic risk (or beta). Using a long span of historical monthly data, the VCMM estimates a dynamic statistical relationship among global risk factors and asset returns. Based on these calculations, the model uses regression-based Monte Carlo simulation methods to project relationships in the future. By explicitly accounting for important initial market conditions when generating its return distributions, the VCMM framework departs fundamentally from more basic Monte Carlo simulation techniques found in certain financial software. The reader is directed to Vanguards 2013 economic and capital markets outlook for further details.

Asset allocation and return assumptions. Our asset-return distributions are based on 10,000 simulations from the VCMM, reflecting 30 years of forward-looking simulations through December 2011. The VCMM uses a statistical analysis of historical data to create forward-looking expectations for the U.S. and international capital markets. The model uses index returns, without any fees or expenses, to represent asset classes. Taxes are not factored into the analysis. Inflation is modeled based on historical data from 1962 through 2011 and simulated going forward.


  • All investing is subject to risk, including the possible loss of the money you invest.
  • Market fluctuations can lower the value of your account, and diversification does not ensure a profit or protect against a loss. There's no guarantee that any particular mix of investments will meet your objectives or provide you with a given level of income.
  • Bond funds are subject to the risk that an issuer will fail to make payments on time and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.
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