engineered portfolio

Corrosion is the slow decay of metallic materials that, over a long period of time, can lead to catastrophic failure of a structure.  Investment fees act in a similar nature, slowly and constantly eating away at your returns and severely damaging your potential to buy that house, put your kids through college or retire when you want.  The good news is that, like an engineer dealing with corrosion, you can avoid the damage if you make smart decisions to protect yourself.

“When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients.”  -Warren Buffett

The investment management industry is designed to take as much of your money from you as possible.  How do they do this?  With investment fees.  They hide the fees in all types of places with all types of names, expense ratios, 12b-1, front end load, bid-ask spreads and so on and so on.  Most people don’t even understand all of the fees they are paying.  The numbers might seems small, 1% here, 0.5% there, but the cumulative effect over long periods of time adds up to an amazing amount of money that is taken from your pocket and put into theirs.  There is a reason that people who work on Wall Street have so much money…..they’ve taken it from you in the form of investment fees.

It could cost you MILLIONS of dollars

Here is a simple example; let’s assume you inherited $1 million dollars from some long lost relative (sweet!) and, being the prudent person you are, you decided to invest it.  You were given the choice of an index fund charging 0.05%  or an actively managed fund charging 1%, what do you do?  There have been many studies showing that actively managed funds have a hard time outperforming index funds over long periods of time.  We will assume that the return of the actively managed fund in this example is identical, before fees, of that of the index fund.  Many people might think something like, “oh its only 1%, no big deal.”  Well I’m here to tell you that it is a HUGE deal.  Having a 1% annual fee (also known as an expense ratio) compared to a 0.05% expense ratio over 30 years would have cost you $1.76 million dollars. No, that is not a typo, see the plot below.

What can you do?

Take action!  Sit down and list out all of your investment accounts, rank them by their balance.  Starting with the account with the largest balance review your investments and the fees you are paying.  There are tons of places where you can look up the funds fees.  I recommend Morningstar (www.morningstar.com).  Simply enter the ticker symbol for your fund at the top of the page (circled in green in the picture below) and review the expense area (circled in red in the picture below).  If you are paying anything over 0.30% I would argue that you can find a lower cost fund.

So how do you find low cost funds you ask.  There are many exchange traded fund (ETF) and mutual fund screeners available, just google “ETF screener” and you’ll have a host of options.  Here is one I recommend.  I recommend ETF’s because they tend to be lower cost than mutual funds.  Make sure you use a screener that allows you to screen out funds with various types of fees.  You should NEVER be paying any sales loads, 12b-1 or any other fees.  I would avoid anything with an expense ratio of 0.30% or greater and I would recommend you be closer to 0.10%.  Here is a link to a list of 100 low cost ETF’s covering a range of different asset classes.  All of these funds have less than a 0.10% expense ratio.

401(k) Action plan – retire earlier, retire better

For some accounts, like your 401(k), you may have limited options in what you can invest in.  In these types of accounts your employer decides the funds that are available to invest in.   In this situation review all of the investment options and along with your asset allocation strategy (for more information on this see our other blogs) choose nice low cost investments.  At my company we use Fidelity, if you use Fidelity you can log into your account, click on the “Investments” tab and then click on the “fees” smaller tab on that page.  This will show you a list of all of your available investments and their associated expense ratio.   In the image below the funds I’m invested in are circled in red, notice how low the expense ratios are compared to some of the other investment options.

So what do you do if most or all of the funds in your 401(k) have high fees?  Pay attention, because this is important and could make a huge difference in your life.  The people that administer your company’s 401(k) plan at your company (often the HR team) are your fiduciaries.  A fiduciary is someone that has both an ethical and LEGAL responsibility to look out for your best interests.  There have been many lawsuits in the past decade where plan participants have sued their fiduciaries.  Most of the time the law suits are based on the plan not offering enough low cost investment options.  Ok, so I’m not suggesting you go sue your company, probably not a great move.  But I do strongly suggest that you engage your companies fiduciaries and petition for improvements to your companies 401(k) plan.  Even getting a few low cost funds added to your plan can make a huge difference.  At my company a group of employees got together and did exactly this.  As a results some great low cost funds were added to our plan.

In conclusion

Protecting yourself from the corrosive nature of investment fees will have a significant positive impact on the performance of your financial assets and also on your life.  Spend a little time now protecting yourself and you’ll reap the rewards for the rest of you life.