Are you getting what you are paying for?

It’s a simple question, but it’s one that is often not asked enough when it comes to investing. Every dollar you pay in fees and expenses is a dollar you will never see again. It also a dollar that can no longer grow into more money.

This is why what you pay for a fund or a strategy matters. It is why the way a firm, adviser or newsletter presents returns matters. It is why Fred Schwed asked more than 75 years ago, “Where are the customer’s yachts?”

Even a 1% fee should raise questions (let alone the 2%/20% charge hedge funds get away with). As Charley Ellis explains on page 6, a 1% fee is costlier than it first appears. Say you own one of those “closet indexer” large-cap funds—the kind that claim to be actively managed, yet are not very different from the S&P 500 index. If both the S&P 500 and the fund achieve a 7% return, you lose 14%. How? Your after-fee gain is not 7%, but 6%, a 14% difference. Raise the fee up to 1.2%, and the loss widens to 17%.

Even when there isn’t a management fee, transaction fees can play a big role. It’s not unusual to see companies pitch newsletters and strategies promising market-beating returns. Ask how they are calculated and you will often find out that they are based on backtesting or paper trades. Run the strategy in an actual portfolio where trading and transaction costs matter and the returns may be significantly lower. All of our portfolios—the Model Shadow Stock Portfolio, the Model Fund Portfolio, the Level3 Passive Portfolio, Stock Superstars Report and AAII Dividend Investing—are run through real brokerage accounts. The returns we publish for each include all trading and transaction costs.

The reason I bring expenses up (it’s not the first time, and it will not be the last time) is because if you are going to pay for active management or professional advice, be sure you are getting what you pay for. Are you getting better returns, more income, better education on how to invest or help in staying disciplined over the long term? If not, then you are probably unnecessarily giving away valuable investment dollars.

There is another cost that is less often spoken about. It’s the loss of return investors realize by jumping in and out of funds and moving from strategy to strategy. This difference—known as the behavior gap, or the return gap—is in addition to the fees charged and expenses incurred. For the 10-year period ended December 2015, Morningstar estimated that this gap cost investors in large-cap funds 0.74% annually. Research firm DALBAR calculates an even higher cost. Regardless of which number one choses to focus on, the reality doesn’t change—constantly jumping from fund to fund or strategy to strategy is costly.

If you are going to pursue an active strategy or passive strategy that differs from the traditional market-cap-weighted indexes (e.g. the S&P 500, the Russell 3000, etc.), make sure the strategy is based on sound research and is run by people who are committed to sticking with the strategy. Then make a long-term commitment yourself. The strategy might have periods of underperformance—all strategies go through periods that fray investors’ nerves—but the good approaches fare well over the long term and more than compensate you for both the costs and the frayed nerves. Most often, the good strategies also have comparatively lower investment costs too.

Speaking of costs, tax time is almost here. If you have losses in a stock or fund you’d like to realize but are uncomfortable about being out of the investment, Ben Branch has some suggestions here. Keep in mind that when you realize a loss in a taxable account, you cannot buy a substantially identical security within 30 days, so watch the calendar.

Wishing you prosperity, 

Charles Rotblut, CFA
Editor, AAII Journal
@CharlesRAAII

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