Tag: Expense Ratio

Index Funds and Passive Fund Management: Understanding the Opportunity

Written by support@seostats.com on March 12, 2018. Posted in Investing.

There is a more cost-effective way to invest your money. Are you taking advantage of it?

In my most recent post, Expense Ratio – The Fee That You Will Never See!, we walked through how you can figure out what you are paying for your mutual funds as well as the total fees paid to have your money invested. To provide an alternative solution to the higher-cost investment options available to you, allow me to introduce (or re-introduce) you to Index Funds.

What is an Index Fund?

An Index Fund can be either a mutual fund or an exchange traded fund. The primary difference between an index fund and a traditional active mutual fund is that it’s designed to track the performance of a market index like the S&P or Dow Jones Industrial Average. For example, if you own an S&P 500 Index Fund like the Charles Schwab S&P 500 Index (SWPPX), and the S&P 500 is up 1% on the day, your holding of SWPPX should also be up 1%. And what makes index funds particularly attractive to investors are their characteristically low operating costs. In the case of SWPPX, the expense ratio is just .03%.

What is Passive Fund Management?

Passive fund management is a portfolio management style/investment strategy where a manager uses index fund to invest. The manager doesn’t attempt to beat the market through active investing strategies of buying and selling securities within investor portfolios. Instead, passive investing focuses on buying and holding index funds through market fluctuations without attempting to anticipate future market performance.

Understanding the history of Index Funds and Passive Management

The very first Index Fund was created on December 13, 1975, by Jack Bogle of Vanguard. He created this new investment vehicle because he came to realize that the majority of actively managed mutual funds and asset managers were not outperforming the market, despite repeated attempts, and that the costs associated with active management were high.

Traditionally, active money managers sold investors on the idea that they could outperform the market and, in turn, yield their clients a higher return than anyone else. Investment managers believed (incorrectly) that they somehow could predict the market. As an example, if the Dow Jones Industrial Average is up 7 percent for the year, an active manager may believe he or she can pick the best-performing stocks in the index while simultaneously avoiding the under-performing ones, thus earning higher than a 7% return. Since an index like the Dow Jones Industrial Average is just an average of the performance of all the underlying stocks, some stocks will earn higher than 7 percent and some will under less than 7 percent. So active managers are betting that they can predict the winners and losers.

Why Index Funds?

To get Vanguard to adopt the index fund, Bogle presented data to show how $1 million invested with an assumed market return of 10 percent would be worth $17.5 million after 30 years. Meanwhile, a similar investment at 8.5 percent (using the 1.5 percent cost differential) would be worth $11.5 million. The point he illustrated was that the cost-savings resulted in a $6 million payoff that was six times the original amount of the initial investment. Vanguard saw the opportunity and approved the index fund Jack Bogle created.

The Big Idea: The less money spent on fees means more money that can stay invested in the market and grow over the long-term.

Today, many investment managers still follow the active investment philosophy and try and “beat the market” by earning a better return. The wealth of data and research that exists now shows individual investment advisors cannot outperform the market in the long-run.

The truth is, no one knows with certainty where the market is headed on a daily, monthly, or yearly basis. You can always find an example of an active investment manager who beat the market for a year or two. But it’s nearly impossible to find evidence of any manager doing so on a consistent basis over the decades of time that most people invest.

Conclusion

Index funds make up anywhere from 25 to 30 percent of all fund investments. These funds mirror an index at a fraction of the cost of a traditional mutual fund that tries to outperform the index.

If you haven’t yet, it’s time to rethink the high cost and poor performance of actively managed mutual funds. But if the data isn’t enough to convince you, the lower cost of investment management just might. Index funds are an opportunity for every investor. Take a hard look at what you are paying for and ask yourself: Is it worth it?

https://www.vanguard.com/bogle_site/lib/sp19970401.html

S&P Dow Jones Indices, “SPIVA® U.S. Scorecard,” Aye M. Soe, CFA® and Ryan Poirier, FRM, July 2017. http://www.spindices.com/documents/spiva/spiva-us-mid-year-2017.pdf

Expense Ratio – The Fee That You Will Never See!

Written by support@seostats.com on February 26, 2018. Posted in Fees.

If you invest in Mutual Funds, you need to read this.

The majority of investors are familiar with mutual funds and the concept of owning a diversified pool of stocks. You purchase one share of a mutual fund and in turn get exposure to all of the individual stocks that the fund holds. By owning multiple stocks, you limit the amount you can lose (aka not having all of your eggs in one basket).

In the same light, most investors look at their advisory statement and can see the quarterly or yearly “advisory fee” they pay from their account (pretty straightforward). Let’s quantify it at 1 percent, and assume that is the total asset management cost.

What I see time and again is that investors are taken aback when they find out the mutual funds they hold in their portfolio also charge them a fee, but that fee never shows up on their statement!

What does an expense ratio pay for?

According to Morningstar, the expense ratio is the annual fee that all funds or ETFs charge their shareholders. It expresses the percentage of assets deducted each fiscal year for fund expenses, including 12b-1 fees, management fees, administrative fees, operating costs, and all other asset-based costs incurred by the fund.

How do I find out how much I’m paying in expense ratios?

Calculating expense ratios is pretty straightforward as long as you have the ticker or symbol of your mutual fund. You can find the ticker by looking at your statement or searching the full name of the fund on Google. Once you have it, just type it in Google and the below will pop up:

In this case, the Fidelity Contrafund has an expense ratio of .68 percent. So, in reality, if you were paying your advisor 1 percent, in total, your all-in fees would actually be 1.68 percent.

How does this fee get paid by me?

Here is the tricky part, these fees can come out of your portfolio in a number of ways.

#1- Taken from your dividends.

As an example, let’s say your mutual fund with an expense ratio of 1 percent is worth $100 a share and pays a 2 percent or $2 dividend per year. At the end of the year when you get paid your dividends, instead of getting back that $2, you only get $1. The fee comes out of your profits, and you never see it as a line item on your statement.

#2 – Taken directly from the fund in the form of cash

For mutual funds that don’t pay a dividend, these monies can sell some of the stock in the fund and instead of being fully invested use the cash that was generated to pay the fees.

Let’s go back to our mutual fund with an expense ratio of 1 percent that is worth $100 a share. When it comes time to deduct the fees, some shares are sold in the fund, and the cash is removed. The day after this happens you look at your statement, and now the fund is only worth $99 per share. Unless you knew what was happening, this would just appear as a price fluctuation due to the market. However, in reality, this was your fee coming out. Again, unless you knew what the expense ratio was, you would never know you just paid a fee!

Conclusion

You can’t just look at your yearly statement and assume you know what you are paying. Therefore, it is in your best interest to ask your financial professional questions about the all-in fees you are paying. If there are less expensive options out there that can help you accomplish the same financial goals, wouldn’t you want your money working harder for you?

If you are managing your investment assets on your own, check the expense ratios of the funds you own as I illustrated above. If any of your expense ratios are between .50% and 1%, it’s time to explore some comparable lower cost options. If you are paying over 1%, then it’s time to switch to a lower cost option.

Lake Road Advisors, a Fee-Only, independent financial planning firm with offices in Corning, NY, Ithaca, NY and Portland, OR works with clients virtually all across the country. Paul Sydlansky, the founder of Lake Road Advisors LLC, has worked in the financial services industry for 20+ years. Prior to founding Lake Road Advisors, Paul worked at Morgan Stanley in Manhattan for 13 years. While at Morgan Stanley, Paul was a senior-level manager within the Institutional Equities Department. In 2018 he was named to Investopedia’s Top 100 Financial Advisors list. Paul received a Bachelor’s degree in Economics from Marist College and holds an MBA from New York University Leonard N. Stern School of Business. Paul is a CERTIFIED FINANCIAL PLANNER™ and a member of the National Association of Personal Financial Advisors (NAPFA) and the XY Planning Network (XYPN).