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Tuesday, March 6, 2012

What You Don't Know Won't Hurt You!

What you don't know won't hurt you.

That's the idiom we used to bandy about a lot as kids.  But it comes into play a lot for adults as well, I guess.

I met with a young lady about asset management.a couple of weeks ago and noticed she held shares of Fidelity Magellan (FMAGX).  This is a huge, widely-held, large cap fund.  Management expenses on FMAGX are relatively low at 0.60% (the average actively managed fund charges in the neighborhood of 1.20%!), turnover is relatively low at 42%, and over the past 3 years, as of 3/5/2012,  has achieved an annualized average return of 25%!

Morningstar data shows that $10,000 invested in FMAGX would have grown to $19,500 over the period!  My guess is that most holders of FMAGX are pretty happy.  What's not to like?

Actually, there's a lot!  Over the same period, the SPY exchange traded fund which is indexed to the S&P 500 achieved a return of 28.3% annualized.  $10,000 invested in SPY would have grown to $21,119.  The difference is approximately $1,600.  Part of this difference is in management expenses. The SPY fund charges .09% considerably below the .59% of the Magellan Fund - it adds up.

A point to consider is what the $1,600 is likely to grow to over the next 15 or so years, taking into account the compounding of returns!

The March issue of Money magazine put out by the Financial Planning Association reports that last year "79% of large-cap fund managers trailed the Standard & Poor's 500...".  They go on to say "These poor results are no anomaly...".  In other words, looking at FMAGX isn't just (as we also used to say when we were kids) "cherry picking."

When I talk to people about asset management fees, I know they balk about the explicit fee, especially if the assets are in a 401(k).  Some feel like they are getting the management essentially for free.  Here's the news:  Wall Street does nothing for free.  Wall Street is making money, believe me.

I charge 0.4% of the market value of assets and invest in low-cost, well-diversified index funds, like SPY mentioned above.  On $1.0 million of assets, this amounts to a fee of $1,000 for 3 months.  After that ,some of my clients manage the assets on their own - possibly with some guidance from me.  I know that $1,000 paid out explicitely seems like a lot; but, in many cases, it is a lot less than what brokers are taking before investors even see the bottom line.  And this includes funds in 401(k)s.

Disclosure:  This post is for educational purposes only.

3 comments:

  1. Fees eat into your gains and these add up over time. Sounds simple, yet I'm always amazed at why people don't get this!

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  2. I just linked this post for my students to read.

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    1. Imagine getting a letter in the mail from the IRS saying your taxes were overpaid last year by $1,600! Most people would run down the street, hopping up and down, whooping it up. Yet when it comes to carefully examining what their investments are costing some tend to be a bit blase. I see it change though when they get in their 60s and the idea that they will really be living off their savings becomes real.

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