Much has been written about the average investor’s inability to “beat the market” and to earn substantial wealth investing in the markets. Personally, I have had my share of success and failures in the market but have nonetheless done well with my portfolio—particularly in healthcare. I recently reviewed the portfolio of a former coworker who had left the firm. This coworker considered hiring me to manage his money. But before I even would consider this, I wanted to review the portfolio and see where the weaknesses and strengths were. I wanted to see its performance over the past couple of years and most importantly, the fees this friend was paying to his broker.
I was aghast when I took a closer look. His portfolio was basically a flatline for most of the past 2 years. Even during the Trump rally, it failed to keep pace with the S&P 500—underperforming by about 150 to 200 basis points. The $440,000 account was scattered among several mutual funds. So I went to my trusty source on mutual fund performance and fees… Morningstar. Of the 6 funds in the account, 2 were absolutely lousy performers, 2 were average at best, and 2 were very good to excellent. As I dug deeper I found the source of his underperformance. It appears his broker put him in C-Class shares of each of these mutual funds. Nearly all of them had expense ratios that were far above the Morningstar averages for those classes of funds he possessed. Most of the funds had annual expense ratios of 1.75 percent or greater! The Morningstar average for a general equity fund is about .80 to 1.0 percent. Index funds are a fraction of that.
So what caused his underperformance? It was the fees. With the market up about 10 percent YTD recently, he was up only about 8%. Funny… he would have likely matched the market if the fees weren’t so onerous. While the Dow and SP 500 were reaching all-time highs, his portfolio was mostly stuck in the mud and all because of excessive fees (and admittedly some bad mutual fund picks by his advisor).
This has been a constant sore spot in the investment management industry; the fees are just too high in some cases. But investors continue to pay high fees to some of these investment management firms. Moreover they get lackluster results – essentially two slaps on the face – high fees and bad performance. Clearly, this is why the online discount firms have had such success, they charge less! And now, with mutual funds and ETFs, the competition is so great that price wars are breaking out. Schwab recently lowered fees on commissions as well as the expense ratios on some of their ETFs. In fact, they undercut both iShares SP 500 ETF and the SP 500 SPDRs in terms of annual management fees.
For those dealing with hedge funds, the fees are substantially higher… 2 percent annually and 20% of profits. The fees with hedge funds became a source of controversy for many pension funds as the performance of these funds didn’t match the fees. In fact, Warren Buffett made a bold bet with a hedge fund manager for a million dollars (to be donated to charity as both sides of the bet don’t need the money) that the S&P 500 over a ten year period would beat a portfolio of hedge fund managers. The bet is over in a few months, and Buffett is nearly guaranteed winning since he is so far ahead. To be sure, some of the fees in this area have started to recede as well, just like ETFs and other investments.
We look for more of this in the future. In the end the investor wins. The more money that goes into the actual investment instead of the broker’s pocket, the harder your investments will work for you. John Bogle, the charismatic former leader and founder of the Vanguard Group, did reams of studies and implored investors to repeat to themselves daily, that COSTS MATTER. We urge you to take this philosophy as your own. Costs matter. And every basis point you can save will compound more in your favor down the road… doesn’t matter if it’s healthcare stocks, energy stocks, ETFs or Mutual funds… COSTS MATTER.
Be careful out there.
David Lerman / Jodie Warner