How Much Are You Paying for Your Portfolio?

The greatest value financial advisers offer is the quality of their advice, the way they help their clients manage their emotions and their investment intelligence. Their next greatest value? Helping to reduce internal investment costs without negatively impacting portfolio returns.

Over the past 20 years the financial services industry has experienced a boom in product innovation. Many of these developments provide investors with the ability to greatly improve their long-term performance simply by cutting underlying investment costs. For instance, if you own a large-cap U.S. stock mutual fund, odds are you are paying roughly 1% in internal expenses plus hidden trading costs for the fund … and you may be subject to considerable dividend and capital gains distributions, further reducing your net after-tax return. If, however, you owned any one of the large-cap ETFs (exchange traded funds) that has similar holdings and portfolio characteristics, you would be cutting your internal expenses by over 0.75% while essentially owning the same portfolio.

For illustration purposes, take the Growth Fund of America (ticker: AGTHX), which has over $162 billion in assets and a very reasonable 0.66% expense ratio. This is a solid fund with a decent track record and a terrific investment for smaller accounts (below $50,000) where trading costs and other outside factors can greatly impact performance. Comparing this fund to the iShares S&P US Growth ETF (ticker: IUSG), the informed investor will quickly notice that its 0.05% expense ratio represents a much better value and significant cost savings.

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Both investments have similar return, risk and volatility patterns, which is why I chose to compare them. However, over time – say the past 10 years – the difference in expense ratios compounds significantly, costing the investor thousands of dollars. In this example, the 61 basis points savings in expenses compounded at the net return of 7% by the Growth Fund of America over a decade (according to Morningstar data) for a $100,000 investment amounts to over $13,000 in additional net returns for the investor.

As a financial professional with over 20 years portfolio management experience I have learned that there are very good reasons to own all sorts of products to implement your investment strategy. And while there are bound to be times when selecting a higher-cost investment makes absolute sense (variable annuities immediately come to mind), generally speaking investors are well served to research and select lower-cost investments.

This column is the fourth in a six-part series on investor education.

• Column 1 – Understanding your goals
• Column 2 – Why benchmarking to the S&P 500 is not a good strategy
• Column 3 – Investors: Focus on Cash Flow, Not Returns
• Column 4 – How much are you paying for your portfolio?
• Column 5 – 5 critical questions to ask your financial advisor
• Column 6 – ‘Senior Inflation’ the not so silent retirement killer