In the world of investing, fees and expenses can significantly impact your bottom line. Whether you're a seasoned investor or just starting out, understanding the various fees associated with investing is crucial for maximizing your returns and achieving your financial goals. From management fees to transaction costs, each expense can eat into your profits if not carefully managed. In this article, we'll explore the different types of investment fees and expenses and their impact on your portfolio.
Types of Investment Fees and Expenses
Management Fees: These are fees charged by investment managers for managing your portfolio. Typically, they are calculated as a percentage of your assets under management (AUM). While management fees can vary widely depending on the type of investment and the manager's expertise, they usually range from 0.5% to 2% annually.
Distribution and Administrative Fees: These expenses cover administrative costs, marketing expenses, and other operational costs. These fees are often referred to as 12b-1 fees.
Sales Loads: Sales loads are commissions charged by mutual funds or brokerage firms when you buy or sell shares of a fund.
Transaction Costs: These are expenses incurred when buying or selling securities within your portfolio. They include brokerage commissions, bid-ask spreads, and other trading fees.
Advisor Fees: If you work with a financial advisor, they may charge a fee for their services, either as a percentage of your AUM or a flat fee.
Expense Ratios
Expense ratios represent the annual operating expenses of a fund expressed as a percentage of its total assets. Most investments bundle all of their fees and expenses into an expense ratio. This makes it easier to compare fees for different funds and investments. Lower expense ratios are generally preferred since they directly impact your investment returns over time. All of these fees and expenses are listed in each fund’s prospectus.
Examples
Let’s look at some examples of fees across some different investing scenarios.
A – Using an investment advisor that buys low-cost index funds
B – Using an investment advisor that buys mutual funds
C – Using an investment advisor that buys individual stocks
D – Buying low-cost index funds yourself
Net Returns after Expenses
It is important to be aware of all of the fees and expenses, but the most important figure is the net return percentage after expenses.
In the example above, the costs to use an advisor that buys mutual funds is the highest at 2.1%. But if this advisor is able to generate much higher returns (3% higher for example), the investor would still end up ahead even after deducting the fees and expenses.
This is very rarely the case, however. Higher fees don’t typically equate to better investment performance. In fact, the opposite is more often the case. Portfolios with higher fees and more complex investment strategies typically have lower investment returns.
As we have shown in our other blog posts, low-cost index funds generate higher investment returns and have the lowest expense ratios.
Financial advisors don’t typically purchase low-cost index funds for their clients because that approach doesn’t provide them with a justification to charge their 1% investment management fee. This is why financial advisor either buy individual stocks for their clients or create complex portfolios comprised on many different assets (stocks, bonds, commodities, etc.).
Using historical performance data, let’s look at the net returns after expense for the four scenarios above. As you can see, the Do-It-Yourself investor can generate the best results if they know how to pick the best low-cost index funds. The DIY investor can generate net investment returns that are almost 50% better than Advisors who buy mutual funds or individual stocks.
These differences in net returns after expenses are a big deal – potentially a difference of millions of dollars over 30 years.
Investing fees and expenses can significantly impact your investment returns over time. By understanding the different types of fees, their impact on your portfolio, and strategies for minimizing them, you can optimize your investment strategy and achieve your financial goals more effectively.
Be well,
Phil
Disclaimers The Beyond Buy & Hold newsletter is published and provided for informational and entertainment purposes only. We are not advising, and will not advise you personally, concerning the nature, potential, value, or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. Beyond Buy & Hold recommends you consult a licensed or registered professional before making any investment decision.
Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.
The investing gurus who predict the future attract a lot of attention. For obvious reasons, we all have a strong interest in knowing if the stock market is going to continue going up this year or if it is headed for a big decline in the next several months. Some of my most savvy customers ask me about my opinions on this topic regularly.
I tell them I don’t know what will happen in the financial markets in the short-term. No one can predict the short-term direction of financial markets with any consistency. It is just too hard, and the financial markets are extremely irrational in the short-term. I think they are often disappointed in my answer.
I do feel very comfortable predicting the long-term direction of financial markets based on history. All investors should have a long-term horizon. Including dividends, the S&P 500 should grow by about 10% per year over the next twenty or thirty years. It has done this for the last 20, 30, 50 and 100 years. It has been amazingly consistent. One does not need to be Nostradamus to make these kinds of easy predictions.
The problem is that it will be a bumpy and volatile ride. This is why I get so many questions about the short-term outlook for the markets. People are concerned about major stock market declines and the losses they produce. I get it.
I could attract more attention as an investment strategist and blogger if I were to make big and bold predictions for the markets for this year or next year. This is called “click bait” in my business.
I could probably get away with it like the other gurus because nobody holds you accountable for your predictions. The gurus never talk about the accuracy of their past predictions, and nobody seems to care.
I don’t do it because I don’ want to waste your time or my time with this kind of nonsense. These predictions don’t matter. Because they are mostly wrong, people should not make any changes to their investment strategy as a result. Selling at the wrong time or buying at the wrong time will cost you a lot of money in the long-term.
The only thing that works in investing is playing the odds and using probabilities. The stock market (S&P 500) is in a long-term growth mode 85% of the time. I would say that those are pretty good odds. As a result, people should have a bias towards being aggressively invested in large cap stock index funds (S&P and Nasdaq).
But the other 15% of the time (bear market collapse) is hugely problematic. Once every six years or so the S&P 500 drops roughly 40% in an average time frame of about 11 months. The investing world ties itself up in knots preparing for and dealing with these collapses. And rightly so. They are awful to live through.
But the investing industry’s solution of buying and holding is not a solution at all. They just don’t have anything better. The professionals are left with repeating the same old “ride it out” mantra. They hate it too, which is why the investing professionals also turn to my Beyond Buy & Hold system.
Because these bear market declines appear out of nowhere and for many different reasons, once again none of us can predict these short-term market events.
But I have proven that you can successfully react to these market meltdowns. When the risk of a bear market collapse is high, we have shown that you can profit from these big declines by moving out of the stock market. But you also need to have a way to move back into the stock market at the appropriate time when the probability of a rebound is high.
Playing the odds and probabilities with powerful data and analytical tools works. It isn’t perfect but it is much better than buying and holding and suffering.
If you simply buy and hold an S&P 500 index fund, you will get a 10% long-term annual return. But you will be forced to suffer through those dreaded bear markets. If you use the industry’s asset allocation approach and use bonds and other assets as a hedge against losses, you will generate a 6.5% long-term annual return AND you will still have to suffer through big losses in bear markets. Asset allocation doesn’t work.
Our Market Signals investing system should generate average annual returns of over 14% including dividends and interest (12.7% without dividends and interest). See disclosures. More importantly, it significantly reduces losses (by 60% to 80%) in bear markets. I think our customers appreciate the safety and protection provided by our system more than the higher returns.
Learn how our system works by downloading your free PDF here. And don’t waste your time listening to the gurus who make short-term market predictions.
Be well,
Phil
Disclaimers The Beyond Buy & Hold newsletter is published and provided for informational and entertainment purposes only. We are not advising, and will not advise you personally, concerning the nature, potential, value, or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. Beyond Buy & Hold recommends you consult a licensed or registered professional before making any investment decision.
Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.
The Solutions are Worse than the Problem
SUMMARY:
Did you ever question the solutions that the financial professionals provide? Are the solutions to the risk of bear markets truly improving your investment results? What if the solutions are lowering your long-term investment returns and not really helping you avoid the pain of bear markets? Is asset allocation a good thing? Are bonds helping or hurting your portfolio?
EVERYONE HATES TO LOSE MONEY
No one likes to see their investments drop by 30% or 40% or 50% in bear market crashes like the one we lived through in 2022. In fact, the pain associated with losing money is greater than the pleasure of seeing your investment portfolio increase in value. So, the investment professionals have designed lots of different strategies to minimize the pain and damage of bear markets in stocks. Diversification and asset allocation are said to be good methods to avoid risk in your portfolio. Fixed income securities or bonds are less risky according to the investment professionals and are recommended for most portfolios. They also tell us to put some of our portfolio in international equity markets or commodities because they don’t necessarily “correlate” with the US equity markets. And because we are so afraid of losing money, we are eager to follow their advice.
BETTER THAN THE WORST
Buy & Hold is a form of disciplined investing, as opposed to emotional investing, and that is a good thing. Fear, if not held in check by discipline, causes people to buy into the equity markets at the top (fear of missing out) and sell at the bottom (fear of getting wiped out). This is the worst mistake that many stock market investors make. So, Buy & Hold is an improvement over the worst possible investing strategy, but should we settle for “better than the worst”? And based on the popularity of Buy & Hold investing and the other strategies that we “must” follow if we pursue Buy & Hold, what are the real costs of Buy & Hold investing? We encourage you to ask those questions.
The other benefit of Buy & Hold investing is that it teaches people to think long-term for their stock market investments. Many people mistakenly focus too much on short term results from their stock market investments. Get rich quick schemes have been around for a long time and will probably never go away. It is important for everyone to understand that money invested in the stock market should stay invested for a minimum of five years. Money that you will need access to in the shorter term should not be invested in the stock market. The stock market is the best place to invest for the long term, but the market can be very volatile in the short term.
THE TRUE COSTS OF BUY & HOLD
There many costs associated with Buy & Hold investing.
Financial and Emotional suffering during bear market crashes
No growth in the value of your stocks for anywhere from 4 to 8 years
Lower returns from your portfolio from bonds
Lower returns and higher volatility in your portfolio from international investments and other asset classes.
FINANCIAL AND EMOTIONAL SUFFERING
This cost is the easiest to comprehend. Anyone who was heavily invested in the stock market in 2000 and 2008 can distinctly remember watching their investment portfolios drop by 50% or 60% or 70%. 2022 was painful but not as bad as the early 2000s. It can be excruciating watching a $500,000 retirement nest egg drop to $250,000 in a short period of time. The emotional suffering that goes along with these scenarios can be devastating. I know I felt awful in both of those crashes.
YOUR INVESTMENTS DON'T GROW
It feels good to see your portfolio rebound from big market collapses. But it can and does take a long time – from four to eight years in some cases. And then you realize that we are all just rooting for our portfolios to get back to break-even. To achieve our long-term financial goals, we need our investments to grow and to not just stand still. The S&P 500 basically went nowhere from 2000 to 2013. Time periods like this can be devastating to your financial plans depending upon your age. If you were early in your retirement or just entering retirement during the early 2000’s, your financials plans were probably thrown into disarray. It can be very difficult to make up for this much lost time.
THE PROBLEM WITH ASSET ALLOCATION
Because the investment industry needs you to buy & hold to keep their fees rolling in, they created the asset allocation strategy. The Asset Allocation strategy pushes people to own bonds and international stocks and small cap stocks to supposedly reduce losses in bear markets. If you are buying and holding, the industry says you need to spread your investment across different asset classes to reduce volatility. But it doesn't work.
The other asset classes also only drag down your returns. Stocks outperform bonds by more than 2 to 1. The S&P 500 has consistently beaten international stocks over the long term. And international equities typically fall by as much or more than the S&P 500 during Bear market crashes. For short periods of time, it is possible that international stocks or other asset classes outperform the stock market, but we should be investing for the long term and not for isolated, short periods of time. So, the investment community has sold you on the benefits of asset allocation and it doesn’t really work in the long term. It was a nice try to deal with the risk of Bear market crashes, but it has cost people lots of money.
Buy & Hold is better than the worst investing approaches out there. But we believe that you should not settle for “better than the worst.”
When you have a strategy like our Market Signals investment system, most of your investment problems are solved. You can invest aggressively in the best performing funds that generate annual returns of greater than 10% because you have protection against the big losses that happen in ugly bear markets.
Grab a copy of our free white paper on Market Signals by clicking here.
Be well,
Phil
Disclaimers The Beyond Buy & Hold newsletter is published and provided for informational and entertainment purposes only. We are not advising, and will not advise you personally, concerning the nature, potential, value, or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. Beyond Buy & Hold recommends you consult a licensed or registered professional before making any investment decision.
Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.
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