You probably know that when you are investing, the financial industry takes some small annual commissions and fees out of your pocket. These fees are called management fees.
But what you probably don’t know is that small commissions are a devil in disguise that can eat up most of your future returns and literally halve your retirement pot. This happens because of the Commission Camouflage Effect.
Let me give you an example. If you invest your money in a simple mutual fund, you are paying a 2% annual fee, give or take. And this doesn’t sound like much. When your financial adviser tells you that you are paying a 2% management fee, your brain says “OK… this is not a problem. They take 2 and I keep 98.”
The problem is that our brain can only do simple calculations: “2% out of $1,000? Hmmm… 1% of $1,000 equals $10, so 2% must be $20. No problem! We did that in school! I’m a math genius!”
But, when you add a longer time period maybe 10, 20 or 30 years, our brain just can’t process the math anymore.
If I ask you how much is 2% deducted annually for 30 years in a market that grows by 8% on average, your brain goes, “Are you kidding me? I’m not R2-D2!”
Our brains are just not wired to calculate complex calculations like this. And that is perfectly normal.
That is why we subconsciously make some assumptions: “If 2% of my invested money is a small number, then a 2% annual fee can’t be a serious problem for me.”
But unfortunately, our brains fail us badly in this case. The harsh reality is that, as a rule of thumb, a 2% annual fee halves your retirement pot in the long run.
The financial industry knows this and takes full advantage of it. That is why they will never explain the effect of commissions over the long run to you. Even if you have the best financial adviser, it just doesn’t happen.
The Commission Camouflage Effect is one of the deadliest concepts in investing, and just by getting to know it, you can save a surprisingly large amount of money.
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