Is misery back?

The misery index is an interesting economic indicator, courtesy of Arthur Okin, a famous American economist. The idea behind it was a sort of early attempt to capture or measure the misery that one would supposedly experience when the economy was not doing too well. It is basically a combination of the unemployment rate and the rate of inflation combined into a single measure. The graph above plots the misery index for the U.S. over the past four decades with the blue bar representing unemployment and the red bar the rate of inflation. From its peak levels in the 70's and early 80's (high inflation and unemployment), the misery index has been steadily dropping with the occasional short period spikes in unemployment (91-93). Inflation has been far more tamed when compared to the late 70's and early 80's. On the other hand, we note a sharp rise in the unemployment rate, according to the most up to date figures (09), a somewhat worrying observation in the context of dire economic conditions!

The impact of compounding...

Compounding (reinvesting investment gains) can have a wondrous effect on your wealth over the long term. Assume that you invest $1 million that grows by 5% annually for a period of 30 years. If everything goes according to plan, you should actually end up with a whopping $4,322,000 which over the entire period is an appreciation of 322%.

But what happens if you include fees in the equation? Assuming in the above example a 3% all in fee per annum, the final amount shrinks to $1,733,000, for a total gain of 73% over the 30 years and a startling difference of $2,589,000 when compared to the "no fee" version. If we cut the fees to 1.5% per annum, we arrive to a total of $2,746,000, for a gain over the period of 174% which brings the difference with the "no fee" version to $1,576,000.

To conclude, compounding has a substantial effect on the rate of growth of an investment. Because the effect is so significant, chipping into it also has a materially negative impact on the long term growth rate. In other words, if you wish to achieve a reasonable growth rate for your investments over the long term, it is not only important to be aware of the total amount of fees that you are paying, but also to ensure that these fees are reasonable and competitive for the services that you are obtaining.

Finally, the graph below illustrates these exact same concepts but in a more realistic setting: investing into the S&P 500 over the past 30 years. The results are no less startling!