In the first two installments of my three-part “hidden in plain sight” investment strategy series, I covered the importance of staying invested to earn market returns while managing the risks involved. I conclude with what may be the most obvious and powerful advice of all, even if it does not seem to receive the attention it deserves: Don’t spend more than you need to.
- Being there
- Managing for market risks
- Controlling costs
Plain-Sight Strategy #3: Controlling Costs
Don’t spend more when you can get the same thing for less. Pretty obvious, right? But this is difficult to do if you don’t really know the fees that you are paying for investing your hard-earned money. While spending less to earn more seems obvious, the costs themselves aren’t nearly as apparent.
As an investor, you deserve full disclosures and clear explanations of all investment management fees, so you can determine for yourself whether the costs are justified. However, there is considerable evidence that investors are unaware of the hidden costs. Adding to the challenge, many investors don’t realize how seemingly modest costs can lead to significantly different outcomes over time.
In a perfect world, fees for everything in your life, including investment fees, would be clearly summarized. But they aren’t always. Sometimes the investing fees are transparent. (Even so, investors should take the time to learn about and pay attention to them.) And sometimes there are obscure fees and hidden trading costs. It’s even more important to know about (and avoid these) if at all possible.
Identifying Expenses: Hidden and in Plain Sight
In short, the first step in managing investment expenses is to know what they are. Here, is an overview of transparent fees and hidden costs of investing.
Trading costs – When you buy or sell funds, stocks, bonds or other securities, you pay a broker a commission to place your trade. These commissions are typically disclosed in your custodian’s trade confirmation statements.
Fund management costs – If you are investing in funds versus individual stocks and bonds, you’ll pay anywhere from a lot to a little to the fund company that manages them. In fact, you can find similar (even almost identical) funds with varying management costs, so it is wise to shop around. These costs typically appear in expense ratio disclosures in a fund’s prospectus or listed as an expense percentage by looking up the fund’s ticker symbol on any number of online services such as Morningstar, Yahoo Finance and many others.
If all investment costs were fully transparent, we could simply choose based on the cheapest rack rate and move on. Unfortunately, if you fail to account for the hidden “gotchas,” you could be losing real money in significant amounts. Evidence indicates that hidden costs can readily exceed those you see. Instead they only show up in the insidious form of lower returns or lost opportunities that are more difficult to measure (but that impact your bottom line just as severely).
Here are a few of the more opaque ways investing can cost you more than is warranted:
Administrative oversight – If you are invested beyond an individual brokerage account containing funds and securities, expect added costs to compensate for the extra administrative oversight and infrastructure involved. Think retirement plans, separately managed accounts, annuities, hedge funds, Real Estate Investment Trusts (REITs), private equity ventures, and so on. This is a key area where hidden costs can fester. As a result, investors often fail to realize there are added costs involved at all, let alone the extent to which they may exist.
Fund manager trading activity – Some fund managers are masterful at aggressively minimizing the costs of buying and selling the securities within their funds, and at responsibly transferring those cost savings on to shareholders like you. Others may not manage their trading costs as adeptly or may pocket any savings for themselves.
Your own trading activity – A poorly managed portfolio can spell a double-whammy against your end returns if you’re investing in inefficiently managed funds, and then you inefficiently manage your own use of those funds in your portfolio.
Tax impact – Similarly, a fund designed to be held within your taxable accounts can be managed with a sensitivity to minimize unnecessary realized taxes for you. You can further manage your taxable portfolio to do the same.
Taking Charge of Your Costs
So, what are some of the steps I recommend for wisely managing your investment costs?
Pay attention to the disclosed costs. An essential first step is to take the time to know what your funds’ published costs are, and whether they compare favorably to other similar opportunities. You’ll find these costs listed in the fund prospectus as fees such as expense ratios, 12b-1 fees and sales charges/loads. You can also find them summarized by Morningstar, along with an assessment of how they compare to other similar funds.
Generally, seek funds with comparably low expense ratios and no 12b-1 fees or sales charges. Reasonably priced expense ratios can be justified as fair compensation for a fund manager’s efforts. Other disclosed costs tend to be thinly veiled kickbacks that compensate salespeople for recommending the fund to you, whether or not it’s in your best interest. These sorts of added costs do nothing to contribute to your end returns and should be avoided.
Research your fund managers’ trading skills. As I explained previously, poor trading management shows up in diminished returns rather than being reflected in a fund’s fees. So how do you know? Cost-effective trading includes incorporating:
- A scientific approach–based on the academic evidence on how our markets have delivered long-term wealth. This helps minimize unnecessary trades and associated costs.
- Patience–to be on the “cool” rather than the “hot” side of the trades. It’s only logical that those who are anxious to secure or unload a position won’t receive the best deals.
- Buying power–being a big enough market player to command superior negotiating power.
Take note of your fund managers’ commitment to client care. After all, a fund manager can charge a little or a lot to be excellent or poor at the job. The goal is to seek a fund manager who aggressively minimizes trading costs and demonstrably passes those cost savings on to you and other fund shareholders in the form of minimized expense ratios and higher long-term performance compared to appropriate benchmarks.
Be your own best champion. The best fund manager in the world can’t save you from yourself. You must also avoid self-inflicted wounds, such as trading too frequently and without a deliberate plan, and failing to account for tax implications.
At Brightview Financial, we’re here to help you build and maintain your investment portfolio in the context of your greater wealth management interests, while also minimizing investment costs. We are committed to fee transparency. Our fees are disclosed on our website, in our client contracts, in the quarterly performance reports, and in the independent statements from our account custodian, TD Ameritrade.