It’s Time to Do “Something”!
Oct 15 2008
The last few weeks are like nothing I’ve ever seen in financial markets. I heard today, that in the last 13 or so sessions there has been only one day that the markets moved LESS than 1%! Just today, the DOW is up over 500 and it was down 700 in the last session. That is volatility like we’ve never seen before and of course the market is way off its high. These are times that really challenge an investing strategy. I’m sure the other authors on these pages would tell you to stay the course and stick with your long term plan…I don’t disagree with them. But, you are or were a Military Officer and military officers don’t sit around while the there is a crisis going on. They do something! So, something you must do. Here is what I believe that something to be. Examine and correct the expenses you are paying for money management. Boring? Yup, but necessary.
Most of us ignore expenses when markets are up 10-15% per year. Who cares if the manager takes a little extra? But expenses become very noticeable when markets return to more earthly levels. And, expenses can vary a great deal, up to 3-4%, besides that increases in expenses don’t always equal increases in performance. So what is one to do? I’ll talk to mutual funds, but the concepts are the same for stocks or managed portfolios. Take a look at the mutual fund’s prospectus…the document you received and maybe skimmed when you bought the mutual fund. In that document you’ll see what the fund charges as expenses. These expenses pay salaries, research, and all the other expenses associated with running the mutual fund. Compare this expense ratio (usually in the form of a percentage) with the fund type (Large Cap, International, etc) average. There are several web sites that have that information. Is your mutual fund above average? Are you getting something for that extra expense? If not, look for a lower expense mutual fund that has the same investment philosophy and similar portfolio.
So does this make a difference? I think it does. Let’s take an example. Suppose you have identical funds with the only difference being that one fund charges 2% in expenses and the other fund charges 1%. If the market returns 8% average over time you’ll receive 6% and 7% respectively each year. What does that mean in dollars and cents? If you invest $10,000; after 10 years you’ll have $1,763 more in the less expensive fund. After 20 years the difference is $6,625 and after forty years the difference is a whopping $46,885. 1% makes a big difference.
What should you do with this information? While the argument rages over whether managed funds outperform index funds over time, there is no argument that index funds have lower expense ratios…you might want to consider that and look at whether your managed funds have beaten the benchmarks over the years. Another place to look is ETF’s some of which offer very low expense ratios. However, a word of caution is in order in that ETF’s do have commissions when traded, so they are probably not a “cost cutter” for systematic investment. But, they do offer advantages for long term holding strategies. You just need to take a look at the math in the specific situation.
I know many if not most of you are itching to do “something” in this market. I understand that feeling. Just make sure the “something” you do is a move in the right direction.
I read an article in Money Magazine that also addressed this. One thing I hadn’t mentioned in this article is the potential increased expenses with a “Life Cycle” Fund. These funds allocate your assests based on a target date. While the theory is sound, you often pay two sets of fees. One for the Life Cycle fund and one for the underlying funds the Life Cycle fund invests in. Something to check into.