When it comes to controlling investment costs, there is a lot of advice out there—some simple, some more complex. Today, I want to talk about one of the more “simple” pieces of advice that often gets overlooked:
Don’t spend more money than you need to.
That sounds like pretty obvious advice, I know, but it can be difficult to keep it front of mind when you’re in the thick of the investing world.
Why Do Investors Spend More Than They Need to?
Let’s Look at the Numbers
Spending less to earn more might seem like the most obvious plan in the world, but the costs are not quite as obvious. In theory, disclosures should protect investors from gratuitous costs, but they are often (intentionally?) written or placed in a way that is less than crystal clear.
It’s not just individual investors who can fall prey to hidden costs. The California Public Employees’ Retirement System (CalPERS) is one of the largest U.S. public pension fund, with over $300 billion in assets as of August 2016.
In 2015, CalPERS administrators set out to cut costs by seeking to eliminate the fund’s most fee-intensive money managers. According to a Pensions & Investments report, CalPERS officials “concede[d] they have been unable to determine just how much they do pay.” If the people who manage one of the country’s largest public pension fund can’t figure out their fees, what chance does anyone else have?
Okay, But What If We Crunch the Numbers?
Many investors don’t realize the long-term damage seemingly modest costs can have over time. For example, a $100,000 investment earning 4% annually would accumulate $220,000 over twenty years. A modest 0.25% annual expense—typical of low-cost index funds—would cost you $10,000. Bump that annual expense to 1%—typical of higher-cost, actively managed funds—and you’re looking at something closer to $40,000.
How Can You Protect Yourself from the Numbers?
We insist on clarity from the funds we deal with and we suggest you do the same. As Vanguard founder Jack Bogle says, “If you had a crowd of investors who said, ‘Look, this is just wrong,’ [fund company] directors would have to listen, whether they want to or not.”
And yet the evidence seems to show that investors are often unwilling to question costs. A 2015 North American Securities Administrators Association (NASAA) report points out that “while broker-dealers may be complying with the technical requirements governing fee disclosures, our research shows that improvements are needed to raise awareness among investors of the costs associated with their brokerage accounts.”
The NASAA report was based on a survey that found widespread confusion among investors. The report concluded: “Brokerage firms routinely charge fees to serve and maintain brokerage accounts, yet nearly one-third (30 percent) of investors said their firm had no such charges and one-quarter (25 percent) indicated they did not know whether they were being charged.” Of the investors who knew there were fees involved, more than half did not know how much.
Clearly, the first step in controlling investment costs is to know what they are. I won’t try to perform a detailed analysis of all-in investment costs here, but I will provide an overview.
Trading costs – This is the cost you pay your broker to place your trade whenever you buy or sell funds, stocks, bonds, or other securities. These are typically disclosed in your custodian’s trade confirmation statements.
Fund management costs – If you’re investing in funds rather than individual stocks and bonds, you’ll pay the fund company somewhere between “a lot” and “a little.” You can typically find these costs in expense ratio disclosures in a fund’s prospectus or by looking up the fund’s ticker symbol online and looking at the expense percentage.
Advisor support – Fee-only advisors like McLean help you build and maintain your investment portfolio in the context of your greater wealth management interests. Our fees are disclosed in the quarterly performance reports we send clients.
Administrative oversight – If your investments go deeper than funds or securities in an individual brokerage account, you can expect to pay more to make up for the extra administrative oversight and infrastructure involved. You’ll generally find this in retirement plans, separately managed accounts, annuities, hedge funds, Real Estate Investment Trusts (REITs), private equity ventures, and so on. Costs can easily hide or just be forgotten in this area. Investors often fail to recognize any added cost, let alone how much the cost may be.
Managing the Numbers
Financial advisors deserve to be fairly compensated, but you deserve to know all of the costs you are paying for our services.
If you want to know more about how we strive for full transparency with our fees, drop us a line.
McLean Asset Management Corporation (MAMC) is a SEC registered investment adviser. The content of this publication reflects the views of McLean Asset Management Corporation (MAMC) and sources deemed by MAMC to be reliable. There are many different interpretations of investment statistics and many different ideas about how to best use them. Past performance is not indicative of future performance. The information provided is for educational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy or sell securities. There are no warranties, expressed or implied, as to accuracy, completeness, or results obtained from any information on this presentation. Indexes are not available for direct investment. All investments involve risk.
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