Controlling investment costsOne of the most effective ways to enhance wealth is to aggressively eliminate unnecessary investment costs, but first you have to know where to find them.

The Two Types of Expenses You’ll Encounter (and How to Spot Them)

You’ll encounter two types of expenses: transparent fees and hidden costs. Transparent fees are readily apparent if you take the time to look for them, but hidden costs usually only show up in the insidious form of lower returns or lost opportunities that are more difficult to measure.

Three Examples of Transparent Fees

Fund management costs – If you are investing in mutual funds versus individual stocks and bonds, you’ll pay anywhere from a lot to a little to the fund manager who manages them.

Trading costs – When you buy or sell mutual funds, stocks, bonds or other securities, you pay a broker a commission to place your trade. These commissions are typically disclosed in your trade confirmation statements.

Advisor support – If you are working with an advisor like McLean Asset Management to help you build and maintain your investment portfolio, the fees are disclosed in performance reports as well as in independent statements you receive from your account custodian.

A Handful of Hidden Costs

If all investment costs were fully transparent, we could simply choose based on the cheapest rack rate and move on. Unfortunately, if you fail to account for the hidden “gotchas,” you are still losing real money in significant amounts. Hidden costs, as a matter of fact, can readily exceed those you see.

Here are a few of the more opaque ways investing can cost you more than is warranted:  

Fund manager trading activity – Some fund managers are masterful at aggressively minimizing the costs of buying and selling the securities in their funds. They are also responsibly transferring those cost savings on to shareholders like you. Others may not manage their trading costs as adeptly, or may pocket savings for themselves.

Your own trading activity – A poorly managed portfolio can spell a double-whammy against your end returns if you’re investing in inefficiently managed funds, and then you inefficiently manage your own use of those funds in your portfolio.

Tax impact – Similarly, a fund designed to be held within your taxable accounts can be managed with a sensitivity to minimize unnecessary realized taxes for you; plus you can further manage your taxable portfolio to do the same.

Markups/Markdowns – This is a nasty hidden expense particular to individual bond trades. When bonds are bought and sold, there is the equivalent of a “wholesale” versus “retail” price. The markup/markdown is the difference you pay above the “wholesale” price; that extra, typically hidden amount goes to the broker on top of any disclosed commissions paid.

How You Can Invest in the Market (Without Paying More than You Need to)

You can combat these hidden costs in a variety of ways. Here are four ways you can do so:

Pay attention to the disclosed costs. An essential first step is to take the time to know what your funds’ published costs are, and whether they compare favorably to other similar opportunities. You’ll find these costs listed in the fund prospectus as fees such as expense ratios, 12b-1 fees and sales charges/loads.

You can also find them summarized by Morningstar, along with an assessment of how they compare to other similar funds.

Generally, you should seek funds with comparably low expense ratios and no 12b-1 fees or sales charges. Reasonably priced expense ratios can be justified as fair compensation for a fund manager’s efforts (with Morningstar’s independent assessment being a good place to start in defining “reasonable”).

Other disclosed costs tend to be thinly veiled kickbacks that compensate salespeople for recommending the fund to you, whether or not it’s in your best interest. These added costs do nothing to contribute to your end returns and should be avoided.

Research your fund manager’s trading skills. Poor trading management shows up in diminished returns rather than in a fund’s fees. So how do you know? Cost-effective trading includes incorporating:

  • A scientific approach, based on the academic evidence on how our markets have delivered long-term wealth. This helps minimize unnecessary trades and associated costs.  
  • Patience to be on the “cool” rather than the “hot” side of the trades. It’s only logical that those who are anxious to secure or unload a position won’t receive the best deals.
  • Buying power, or being a big enough market player to command superior negotiating power.

Take note of your fund manager’s commitment to client care. After all, a fund manager can charge a little or a lot to be excellent or bad at the job.

The goal is to seek a fund manager who aggressively minimizes trading costs and demonstrably passes cost savings on to you. This could be in the form of minimized expense ratios and higher long-term performance compared to appropriate benchmarks.

Be your own best champion. The best fund manager in the world can’t save you from yourself. You must also avoid self-inflicted wounds such as trading too frequently and without a deliberate plan, and failing to account for tax implications.

The One Thing You Don’t Want to Forget

In considering best practices for managing your investment costs, some steps may seem simple enough, such as comparing costs on Morningstar. Others — such as conducting deep due diligence on fund manager performance and client-care metrics, assessing current academic insights, and maintaining a tax-efficient portfolio — are more challenging.

This is why you don’t want to forget your financial advisor. It pays to have an experienced guide by your side.

Contact McLean today to see what our financial advisors can do for you.


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