Whether a simple language blunder or insight into the psychology of the rich and powerful, Svanberg’s comments touch on a belief held by many – that in this world there are rules for the privileged and then rules for the rest of us little people, conjuring up memories of the late Leona Helmsley’s famous statement that, “only the little people pay taxes”.

Wall Street is founded on the little people premise. One manifestation is seen in the ubiquitous conversation by wealth managers about AUM or Assets Under Management. AUM is the measuring rod of their success and compensation -a topic of their urbane, cocktail-party banter. Every wealth manager or investment adviser is aware of his AUM as well as that of their friends and competitors because it indicates how much one earns.

Wealth managers trim 1% to 1.5% in fees off of “their” AUM every year. The bigger your retirement account, the more you add to your manager’s AUM and you become a “bigger person” in his eyes. If your account is under $500K, you are likely a little person. Some top managers won’t even answer you’re call if you can’t add $5 million to their AUM.

While AUM is the accepted business model, we have a huge problem with it. What value does a wealth manager add that gives him the right to extract a fixed percent every year off the spoils of your life’s work?

We deliver our advice to all for the same low cost regardless of a portfolio’s size. We treat every investor as a big person. There are no special investors who are on the inside track with access to special insights or favors.

At MarketRiders, we’ve begun measuring our success, in part, by AOM, or Assets Out of Management. We track the amount of draining fees from the AUM game that we’ve helped you escape. This week, we celebrate reaching $500 million of AOM and you — our thousands of investors that are now saving millions in fees. Here’s to no little people!

If you haven’t sold your actively managed mutual funds, then at least look at what you are paying for them. You’ll get a free customized report comparing your mutual funds to ETFs in seconds. Here is the link: Mutual Fund Fee Analyzer. Pass it along to friends and family you care about.

Once you find out how expensive your funds are, you might say: “I have good mutual fund managers. They do beat the market.” You are missing the point – it’s not the fund, it’s the portfolio. As Rick Ferri says in last week’s Forbes article, “we buy a portfolio of five or more funds. Accordingly, the right question that investors should ask is this: What is the best portfolio approach?” He then proves that the chances of a portfolio of mutual funds beating the market are close to 0% over a long time horizon.

“The more active funds you own, the smaller the chance you’ll beat an all index fund portfolio. A portfolio composed of five actively managed funds had a 32% probability of beating an all index fund portfolio over one year, 18% over five years, 11% over 10 years and just 3% over 25 years.”

Next you owe it to yourself to ask: Who’s really in charge of your mutual fund?  How are important decisions made? Read this recent Wall Street Journal article that addresses those questions. ”When mutual-fund investors think about who’s responsible for the performance-or underperformance-of their shares, they usually tag the fund manager.   In doing so, though, investors too often ignore the people who ultimately oversee their funds: the fund trustees. The trustees have a legal responsibility to evaluate the performance of fund managers, the power to hire and fire them, and the authority to set the fund’s fees as well.”

So now, after knowing what you know, consider looking at ETFs.  A must read is Tools To Help Pick ETFs.  ”Exchange-traded funds have become increasingly viable as core ingredients of a diversified portfolio. Originally pitched as low-cost alternatives to stock index funds, ETFs are now available for almost every asset class.  But with more than 800 ETFs on the market, choosing which funds to buy has become more difficult.  Some online services from brokerage firms and others can help with both tasks…”

Hopefully, after using the mutual fund fee analyzer and reading these articles you’ll finally be convinced to sell every actively managed mutual fund that you own on Monday and replace them with low cost ETFs. It could mean the difference between retiring in a tent in your backyard instead of in a villa in Cabo.

So when it comes to investing in any type of fund, be it index mutual funds, exchange traded funds (ETFs) or mutual funds, investors need to be their own advocate.  Do your homework to understand your true costs as no two funds are exactly alike.  ’Americans save trillions of dollars for college education and retirement by investing it with funds managed by industry and giants like the Vanguard Group and Fidelity Investments.’

If you are new to the game, beginners should brush up on Investing 101 basics. There are a lot of choices. Make the smartest choice for YOU.  Just remember, time is your friend.  Money spent on fees today, compounded over time, is money that could be sitting in your retirement account. Do your homework, you will thank yourself later!

To paraphrase Warren, most investors should “do as I say, not as I do.”  The world’s greatest investor warns us against trying to imitate his stock picking abilities.  His unwavering advice for years has been to buy index funds because:  a) very few people have it in their DNA to be a great investor, and b) those who charge you for their investment expertise can rarely outperform the market due to their onerous fees.

To bring home his advice we’ve pulled together a rare 8 minute Buffett video, evidence a $1 million bet he made, and a fable that he wrote.

A Fable.  Read excerpts from Berkshire Hathaway’s 2005 and 2006 annual reports where Buffett describes what happens to the imaginary Gotrocks family when they begin taking help from Wall Street.

“…imagine for a moment that all American corporations are, and always will be, owned by a single family. We’ll call them the Gotrocks… In the Gotrocks household everyone grows wealthier at the same pace, and all is harmonious.  But let’s now assume that a few fast-talking Helpers approach the family and persuade each of its members to try to outsmart his relatives by buying certain of their holdings and selling them certain others….  The more that family members trade, the smaller their share of the pie and the larger the slice received by the Helpers. This fact is not lost upon these broker-Helpers: Activity is their friend, and in a wide variety of ways, they urge it on.”

The $1m Wager. Buffett bet Protégé partners, a fund of hedge funds, $1,000,000 that over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S & P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses.  Buffett’s bet is a bet on high fees.  His view:  regardless of how good the money managers are, the hedge fund fee structure is so high, that it will, over 10 years, wipe away any gains achieved from beating the market.

The Lecture. Warren Buffett spoke to a group of students at the University of Florida and answered questions for ninety minutes about his investment philosophy.   Fast forward to the 1:15 minute mark on this great video where he says:

“If you are not a professional investor, if your goal is not to manage money in such a way that you get a significantly better return than world, then I believe in extreme diversification. I believe that 98 or 99 percent – maybe more than 99 percent – of people who invest should extensively diversify and not trade. That leads them to an index fund with very low costs. All they’re going to do is own a part of America. They’ve made a decision that owning a part of America is worthwhile. I don’t quarrel with that at all – that is the way they should approach it.”

Just because you can pick up a golf club doesn’t mean you should bet all your savings on your getting on the PGA tour.  And just because you (or someone in a suit at an investment management firm) can place a trade at an online broker, doesn’t mean you figure out a better strategy than using index funds in an asset allocation strategy for your retirement investing.

Do as I say, not as I do.  Thank you Warren.

Robert Powell of MarketWatch uncovers in his recent article ‘Advice You Can Count On?‘ the dirty little secret of many managed IRA accounts – fees are out of control and returns are down. This has led to recent legislation to bring some fairness back to IRA investing.  Even the White House has chimed it stating, “if investment advisers receive compensation for steering workers into investment options with high fees and expenses, they face conflicts of interest that can undermine the reliability of their advice.”

It may be years before any law is passed protecting you from high fees and expenses, so in the meantime consider taking matters into your own hands by managing your own portfolio and investing in index funds or exchange traded funds.  The money saved on fees will compound over time making for a more financially stable retirement.

]]> http://www.marketriders.com/blog/watch-out-for-unnecessary-fees-in-your-ira/feed/ 0 http://www.marketriders.com/blog/study-reveals-indexing-wins-again/ http://www.marketriders.com/blog/study-reveals-indexing-wins-again/#comments Tue, 09 Mar 2010 21:32:53 +0000 Sally http://www.marketriders.com/blog/?p=480 For those that have taken to indexing over the last several years, we have John Bogle, pioneer of indexing and founder of The Vanguard Group and Vanguard index funds, to thank. A recent study by Standard & Poor’s revealed that “actively managed mutual funds beat their benchmark index in 2009. No surprise here: Just 39.2 per cent of Canadian equity funds beat the S&P/TSX composite index, an underperformance that fits in with other scorecards released by S&P.”

I guess you don’t have to be a US citizen to get underperformance in your mutual funds. According to a recent article in Canada’s The Globe and Mail, “Longer-term, though, the results are more discouraging for mutual fund investors. Over three years, only 12.5 per cent of actively managed funds beat the index, and the average annualized return drops to a loss of 2.4 per cent. And over five years, just 7.45 per cent of funds beat the index, with an annualized gain of 4.5 per cent, versus a 7.7 per cent gain for the index.” As short sighted as we may all become, we can not lose site of a longer timeframe, and the financial benefits of investing in index funds — that is if we want to be financially comfortable when it comes time to retire.

This past weekend’s Wall Street Journal ran an article titled Earlier Retirement:Beating Back High Fees that thankfully discusses how many employees are finally starting to challenge their employers on 401(k) fees within their company plans.  This article offers some great warning signs and tips. My vote is to work with your employer to have them entertain offering index mutual funds and exchange traded funds to the investment options mix. With their low cost fee structure, one can then actually look to earlier retirement.  For beginners new to the investing game, or those that are nearing retirement, investing in index funds and exchange traded funds in fees alone will allow you to retire earlier than you would paying the higher fees inherent in mutual funds.  That too, is only the beginning as returns on index funds have been quite promising over the years relative to mutual funds.  I encourage you to check them out.

The 2% you’re giving Wall Street can become 20% of lost investment profits when you consider the effect of Law of Compounding. If you factor the taxes you may pay as they churn your account, you can add another 1%, which means you’re going to give away 30%. But before you shut down the calculator, consider the sobering fact that when a fund does worse than the market, the loss will be even higher. And don’t forget about marketing charges and hefty sales loads on some funds. This kind of wealth erosion is eye opening to a lot of people, beginners as well as the average investor. With baby boomers now living well into their 80’s and 90’s, who can afford to put a nest egg in these hands?

Instead of turning to mutual funds and investment advisers, investing 101 of late would have you look to index mutual funds and exchange traded funds.  These investment vehicles will keep your fees and taxes lower while earning you returns of leading indexes.

As Mamundi states, “While it has been established that most actively managed mutual funds lag behind their indexes over time, [this] study further twists the knife: Active management suffers even more by comparison on a risk-adjusted basis. The study found that in many cases where an actively managed fund beats its index on an absolute basis, the additional risk it took didn’t justify the returns earned. Not only should that be a warning sign for investors — because greater risk means greater volatility — but it also suggests that fund managers aren’t living up to what is expected of them.”

As Mamundi points out, it is typically thought that a riskier fund should reward investors with higher returns, but contrary to this popular thinking, over the past three years higher risk has equaled lower returns. Travis Pascavis, director of equity indexes at Morningstar, further explains that, “The key to thinking of risk in terms of returns versus an index is that, in theory, if investors wanted to take on more risk for greater returns, they could simply buy an index fund and lever up their exposure. That would also increase returns while adding risk — and do so at a cheaper cost than most actively managed funds. It is against this standard that actively managed funds should be judged.”

Although we at MarketRiders do not encourage adding risk to a globally diversified portfolio of ETFs via leverage or any other means, it is interesting to note that highly paid money managers once again seem to be the only ones benefiting from their higher-risk game.