High Fees and Low Cost ETFs

If you are a serious investor and don't know who Jason Zweig is, you should.  His book, Your Money and Your Brain, is a must read.  Very well written, it will make every investor better.

Recently he has examined a use of ETFs, When Cheap Funds Cost Too Much,  that overrides one of their  biggest benefits:  low expenses.  As Zweig points out, some advisors use ETF strategists--thereby adding a 3rd layer of fees to the investment process.  There is the advisors's fee, the strategist's fee, and the expenses of the ETF itself.  He points out this can drive costs to between 1% and 3% of portfolio assets.  Included may be a transactions cost incurred when ETF funds are traded.

A broader issue Zweig discusses is that strategists frequently provide performance results that are not real client performance results - they are back-tested results.

All of this can be avoided, and is, by numerous advisors.  I, like some other advisors, for example, index the market, avoid the "middle man" strategist, and use mostly commission-free ETFs.  Performance, in line with the objective,  is going to be close to the benchmark.  For example, here is performance for a typical client (note that it is up-to-date and can be seen by the client anytime she wishes by going online!):

Source:Schwab

CLICK TO ENLARGE
As you can see, performance since inception of the account is within .20% (average cost of ETFs) of the benchmark.  Note that the benchmark is explicitly listed in the footnote.  Each client has a specific benchmark reflective of their risk tolerance.

My fee is .4% to set up the account, manage it on an ongoing basis, and rebalance as necessary - all mystery eliminated voila'. Total cost, all in, is .6%.  If she did it herself, it would be .2%.  As a matter of emphasis, the layers pointed out by Zweig results in the usual opaqueness in fees and costs that Wall Street is adept at creating.

A Tool for DIY Investors - Schwab ETF Select List

There are now thousands of ETFs, and they are proliferating almost faster than stink bugs. The challenge today is how to select among all the ETFs available.

One approach is to use, or at least start with, the Schwab ETF Select List. This list highlights the best ETF for each category, according to Schwab, based on wide ranging criteria, including "...assets under management, length of track record, trading volume, bid-ask spread, tracking error of the ETF to its underlying index....." The investor considering this resource should read the one-page write up of the selection process. DIY Investor and the working guy carrying all the tools, likes the fact that the list "...excludes leveraged ETFs, inverse ETFs, ETNs, actively managed
ETFs, muni bond ETFs with underlying holdings subject to AMT, and unmanaged baskets of securities."

Source: Schwab

How would a DIY investor use  this list?  Suppose, for example,  after the recent events in Japan, you were interested in seeking a Japan ETF. One way to proceed would be to pull up the 2-page Select List and look at the "International Equity ETFs" shown on the left.  CLICK TO ENLARGE.  Immediately, you find a Japan ETF, EWJ, and see its expense ratio and whether it has a trading commission.

Test question:  How fast can you find Schwab's recommended ETF for the telecommunications sector?

Disclosure:  I am not affiliated with Charles Schwab. The information in this post is for educational purposes only.

Invoice Time

By now, you have received account statements from your brokers and have hopefully figured out your performance. If your situation is unwieldy and involves a number of accounts at a number of brokers, then this can turn into an arduous task. But it is one that you need to carry out and fully understand.

As shown in a previous post, calculating performance is fairly trivial if you are invested in exchange traded funds and can be done on a timely basis. As reported in the post, the return on the diversified portfolio of exchange traded funds, comprised of 30% bonds and 70% stocks, had a return of -3.1% over the first 6 months of 2010 and was calculated on 7/2.

When you do a financial plan, a particular return is assumed on your investable assets. Typically it is on the order of 6%. In many instances, this return must be achieved over the long term to reach your goals of retiring when you want to, leaving an inheritance etc. It is, therefore, vitally important to keep track of the return on your assets. How have your assets performed year-to-date?

How did you do?
A major purpose of my blog is to convince people that (1) you don't need to give away your nest egg for exceptional investment performance and (2) if you are so inclined you can learn to invest your own money. On an historical basis, the evidence shows that the approach recommended here has outperformed 8 out of 10 professional managers over the long term. It is why Warren Buffett, John Bogle, Charles Ellis, Burton Malkiel and many others recommend low-cost investing using index funds. Furthermore, it doesn't require a lot of time, resources or (contrary to what many want you to believe) an MBA.

The Invoice
If you have an advisor, take a hard look at your invoice. Somewhere on the invoice is a charge for investment services. This typically amounts to 1% to 2% of the market value of assets managed. If it is 1% and you have $1.0 million in market value of assets being managed, then you will see a charge for $2,500 for the quarter. Compound this $2,500 over 20 years, and you get the full impact of the charges.

If the advisor has your assets invested in actively traded mutual funds, then you have more costs that you can't see! Actively traded mutual funds charge on average approximately 1.5%. And this is just considering a fee-only advisor. It gets even worse if you are using a broker who is getting commissions based on the products they are putting you into.

The bottom line is this: You don't have to let your nest egg get eaten up by all these costs. If you want to explore your situation specifically, give me a call (443-896-4123) or drop me an email. Poor performance combined with excessive fees eat away at your nest egg and consequently could upset retirement goals.

photo by: Graeme Weatherston

"Greenfest" on Saturday

I will have a table at  "GreenfFest" to be held at Howard Community College in Columbia, Maryland on Saturday.  I will be available to talk to people about investing in "green" companies (actually the more prevalent term in the investment world seems to be "Cleantech").

In line with my overall philosophy, I would limit direct exposure to this sector to 20% of total assets. I would recommend, as well, that investment in a single ETF be limited to 5% of assets and for a single company it be 2.5%. This is a volatile sector where you could hit a homerun or easily strike out.

Today there are a lot of forces converging to make this a significant growth area. But it also is an area of intense competition and is affected by the price of fossil fuels.

Solar seems to be the first area of promise with wind power a distant second and biofuels a sort of wild card. Geothermal and wave power are on the fringe.  All of these face an uphill battle to become competitive with a massive infrastructure that is already in place.  From a different perspective, there is a lot being done to become more efficient (energy efficient homes and office building construction etc.) and to clean up fossil fuel energy production.

I look at this a bit like bio-tech.  Bio-tech companies have enormous potential, but the specific companies are very difficult to analyze unless you are a scientist and want to specialize in the area.  The drugs are complicated, there are trials, companies burn through cash and many have never made a profit, patents expire etc.  In the end, I think it is best to select a good ETF or fund that is well diversified.  To me, it is exactly the same with "green " companies.

Thus, if you want to do good and do well at the same time, I would recommend ETFs.  FAN will get you windpower and TAN will get you solar. Check these out on Yahoo Finance and, in particular, their specific holdings.  There are, of course, many other ETFs - these are just examples with cool (pun!) tickers.

As usual this is intended to be educational. .  eaders should do their own research and consult with an advisor before making an investment.