Getting A Clear Picture
Many investors understandably focus on the returns of the securities in their portfolios to the exclusion of the true costs of those holdings. While some individuals are unaware of the various types of expenses their accounts are subject to, other investors don’t appreciate the impact of those fees on their total long-term returns.
Let’s peel back the layers of expenses that may effect your portfolio to better understand their influence on returns and what you can do to mitigate those costs.
Management Fees
Many advisors charge their clients an annual management fee which consists of a percentage of assets in the individual’s account. This fee, which can be in the 1% to 2% range, often serves as an advisor’s primary source of income to both offset operational expenses and to generate compensation for themselves and their staff. In addition, this management fee may also be pitched as covering other services (estate planning, insurance brokerage, etc.) which an investor may need only infrequently, if ever, yet gets charged for every year.
In any case, investors sometimes assume that this fee represents the total cost of their portfolio; however, this expense is just one piece of the puzzle.
Product Costs
The investment products that advisors select for their clients’ accounts each come with their own costs, including expense ratios, front-end loads, and others. These fees vary widely: while some expense ratios are just fractions of 1% per year, others are several percent; while many funds don’t have front-end loads, others charge a fee of 5% or more of your invested capital on day one… making profitability (or even breaking even) a struggle right from the start.
Advisors who select these higher priced alternatives in an asset class are often doing so to purchase the ‘expertise’ of an active fund manager. However, active managers frequently underperform their benchmarks after fees…so you can end up paying more for less. Additionally, relationships between an advisor’s firm and the company selling the investment product may impact an advisor’s decision about what they choose for their clients.
Trading Costs
The charges for executing trades in whichever securities an advisor chooses are another component of total costs. Depending on the platform that an advisor uses, the securities they trade, and the other brokerage firm services that are received, costs can vary widely. Whatever the arrangement, mutual funds are often more expensive to trade than some alternatives and any trading costs must be included in a calculation of total portfolio expenses.
The last, and most obvious, component of trading costs will be how frequently an advisor trades. If those trades are generating positive returns, then profits are likely to outweigh the negative impact of the associated costs. However, attempting to time the markets and pick tops and bottoms is a notoriously difficult game, and many investors in successful products have seen dismal returns by virtue of their buy and sell timing decisions.
How Big Can The Impact Really Be?
An example will probably be most helpful: Let’s say you were to invest $100,000 with two hypothetical advisors that each invest in securities which generate a 10% gross return for each of the next 10 years, and each incur the same trading costs. However, let’s say that Advisor A charges a 1% of assets under management annual fee and uses products with a weighted annual cost of 1.15%. Let’s assume that Advisor B charges 0.75% and uses securities with a blended cost of 0.40% to obtain the same exposures.
Based on the same invested capital, the same securities returns, the same trading costs, and only a 1% difference in total expenses, what would be the difference in the ending account value between Advisor A and Advisor B on that $100,000 account after 10 years? More than $22,000! That’s right – the client of Advisor B will have a portfolio worth 22.3% more than the client of Advisor A, strictly as a result of fees.
How Can You Improve Your Returns By Managing Expenses?
1. Look for lower management fees. Do you know what your current advisor is charging and what you’re getting for that? At my firm, Holos Asset Management, we implement an efficient, model-driven investing style that allows us charge just a 0.75% annual management fee on our smallest accounts, with larger clients paying even less.
2. Use cost efficient investing products. With many mutual funds charging high fees and underperforming their benchmarks, why not look for alternatives? At Holos we use ETFs, which offer tax efficiency, are often cheaper to trade, and frequently have much lower expense ratios. We prefer ETFs offered by WisdomTree for their fundamentally weighted construction and competitive costs. The blended total product expense ratio in our most popular portfolio is approximately 0.40%.
3. Don’t throw away returns on excess trading. Commissions are the obvious impact of excess trading and they can negatively impact your returns. However, the effect of unsuccessful market timing trades can hit you with the one-two punch of increased commissions and underperformance. At Holos we use allocations guided by fundamental valuation analyses and then allow our securities time to revert to fair pricing – no trading for appearances’ sake.
An advisor’s investment strategy for managing your money is certainly the key to your success, but you cannot underestimate the impact of expenses. While our performance at Holos speaks for itself (and is available on our website: www.holosassetmanagement.com), our mission includes charging a fair fee, using the best and most cost-efficient products available (with no business conflicts to effect our selections), and executing a disciplined, long-term investment approach via inexpensive trading platforms.
Disclosure: None
Disclaimer: This article is for informational purposes only and does not express an opinion or constitute an offer by Holos or any of its officers, directors, employees or agents to buy or sell any particular security or financial instrument or to provide any investment advice or service. All investment management services are offered through the presentation of Securities and Exchange Commission Form ADV, personal contact with Holos representatives and the execution by you and Holos of an investment advisory agreement.
The information in this article is descriptive of the investment strategies of Holos and the services and strategies described may not be available to, or suitable for you. Any strategy selected must be consistent with your investment objectives, time horizon and financial goals as well as needs. These services may be subject to change without reference or notification to you. These methods of investing subject you to the risk of loss, including the risk of losing all invested capital. There are also tax implications of these decisions and we do not provide tax advice.
This article may contain facts, opinions, data and recommendations (including forward looking statements) of third parties or organizations that Holos believes to be reliable, but Holos does not warrant or guarantee the accuracy of such information or otherwise endorse the views of such organizations.
