Friend-of-the-blog James sent in a great question this week. Let’s get him an answer.
James has a Health Savings Account (HSA)** through his work.
He’s able to stow away $7200 per year tax-free. And he can invest that money—sweet!
But James’s HSA has a serious flaw: it charges James $25 whenever he makes a “trade.” In this context, a “trade” can be thought of as any instance where James invests his HSA money.
So James is faced with an interesting problem…
**Note: if you aren’t familiar with an HSA, read this. My friend Roger highlights all the important stuff you need to know.
If James invests money every month, he’ll be charged $25 every month. These fees destroy potential profits!
Instead, James could invest every other month, every third month, or even only twice a year. This would reduce the number of $25 fees he pays. That’s good!
However, this infrequent investing schedule means some of James’s money would be “sitting on the sidelines,” not invested in the market. And as any good finance blogger would tell you, time in the market is a key to long-term investing success. The sooner James invests his money, the better.
What should James do?
Invest every month and pay more fees?
Or invest less frequently and see less growth?
Let’s see what the math says. We’ll build a little model with the following assumptions:
- James adds $600 per month to his HSA—and can invest it if he chooses.
- James will see 7% annual returns on his investment
- Note: I love pointing out how actual returns from the stock market never look like average returns. But when making decisions like this one, using average returns is so much easier.
- There’s a $25 fee whenever James invests.
- We assume zero on-going expense ratio (FZROX and other Fidelity funds have no expense ratio)
- Any money that’s not invested earns 0% return. It just sits in James’s HSA account.
Option 1: Invest Every Month
First, let’s look at James’s situation if he invested every month—and paid that $25 fee every month!
Before we even start, realize this: $25 out of $600 is 4.2%. That is a huge fee to pay. But it’s only a one-time fee.
Turns out that the long-term effect of these one-time fees is fairly minimal. That’s good news!
Over 30 years, the fees act as the equivalent of a 0.142% expense ratio. If you know anything about expense ratios, you know that’s reasonable.
Instead of returning the true 7.00% per year, James’s investment only returns 6.85%.
It will cost him $29K out of what could have been $706K.
That’s a 4.2% drag (hey! It’s our 4.2% friend again)
Not a bad price to pay for access to investments.
Option 2: Invest Every Other Month
Let’s repeat the process, except James will now invest every other month.
James saves up $1200, invests it, and pays $25. This is “only” a 2.1% fee on his principal. But he didn’t have any money growing during Month 1.
The trade-off pays off.
The fees equate to only a 0.08% expense ratio. His investment return is 6.91% per year.
He “loses” $17K out of $706K a.k.a. a 2.4% drag on his total portfolio.
Therefore, every other month is better than every month.
Invests Every 3, 4, 5, 6 Months
Let’s repeat the process for every third month, every fourth month, etc. The results are in the table below…
|End Portfolio||Total Drag ($)||Total Drag (%)||Effective Expense Ratio||Annual Return|
|…Every 2 Mos.||$688,990||$(16,790.23)||2.379%||0.080%||6.914%|
|…Every 3 Mos.||$691,918||$(13,861.72)||1.964%||0.066%||6.929%|
|…Every 4 Mos.||$692,394||$(13,386.51)||1.897%||0.064%||6.932%|
|…Every 5 Mos.||$691,890||$(13,890.38)||1.968%||0.066%||6.929%|
|…Every 6 Mos.||$690,898||$(14,881.91)||2.109%||0.071%||6.924%|
As you can see, James’s most effective plan is to invest his money every 4 months.
That’s where he minimized the combination of 1) drag from monthly fees and 2) the opportunity cost from leaving his money out of the market for too long.
Over 30 years, this plan “saves” James about $16,000 compared to the “invest every month” option. Finding $16K from a 1-hour spreadsheet seems worthwhile.
If you want to play around with the numbers yourself, check out this Google Doc.
This problem is another great example of what we learned last week: if math can help solve a problem, pursue that math!