Fees are one the biggest factors that you can control that play one of the largest roles in your long term investment performance (source). In addition, with valuations near the upper end of their historical range (source), and estimates of long term returns in stocks reaching only 3-4% (source) (today’s CAPE ratio of 25.6 roughly translates to about 3.4% in future returns), it’s important to drive costs down whenever possible so fees don’t eat up all your future returns.
This is how we saved a client over $4,000 in fees every year from their previous financial advisor.
When we met her, her portfolio was largely invested in proprietary mutual funds from SA Funds, a group of funds advised by Loring Ward. Her previous advisor worked for Loring Ward, and so it’s little coincidence given the incentive structure (advisors are paid more when clients are invested in Loring Ward funds) that he invested her into these funds.
Correlations among all stocks to the S&P 500 is quite high. That roughly means that no matter what U.S. stock you pick, whether it’s a technology stock or a consumer discretionary stock, odds are they will move up and down at the same time as the market. That also means the returns from actively managed mutual funds that largely adhere to the holdings of its benchmark index will tend to hug the returns of the index. Take a look at all the sector correlations to the S&P 500 since December 1998:
If you’re going to get similar returns from actively managed funds as you would the index, then why pay the extra layer of fees for active management when you can avoid them? This is something a lot of investors don’t realize. The evidence is overwhelming against actively managed funds (source) and it suggests you could do better over the long term just buying the indexes if you want exposure to the markets. And by doing so, you’re able to eliminate a big layer of fees.
For example, why invest in the SA Real Estate fund (symbol SAREX) with a fee of 1.00% (which the client actually owned) while it has a 0.92 correlation to the Vanguard REIT ETF (symbol VNQ) that has a fee of only 0.12%? We eliminated that layer of fees by going with the index.
Another fund she owned, the SA US Core Market fund (SAMKX) with a fee of 1.00% had a 0.96 correlation to the S&P 500 index ETF (symbol SPY). That was another layer we eliminated by going with an index fund (we chose the Vanguard Dividend Appreciation ETF, symbol VIG that charged only 0.10%)
Overall, the total fees from her SA funds were $4,537 per year. The fees from the index ETFs we used instead were only $434 per year, for a savings of $4,103 per year.
In addition, after interviewing our client, we had discovered that her risk tolerance was far lower than her previous asset allocation suggested. She was 74% invested in stocks, with the rest in fixed income and cash holdings. A large part of the stock holdings (26%) was concentrated in a single company, so we shifted the overall allocation to a more conservative target mix of 50% stocks and 50% fixed income and cash.
Historically, a diversified 50% stock / 50% bond allocation has had a very good risk/reward trade-off: in exchange for about 0.6% of annual return per year, such a portfolio had about 26% less risk (volatility), and in the worst year (2008), its maximum loss was about 40% less than the previous portfolio’s (source). The numbers only roughly translate to the client’s situation because of the single stock concentration, but in any case, a more conservative allocation was warranted.
In the end, we had a very satisfied client. Her portfolio was more in line with her risk tolerance and was able to cushion a lot of the recent shocks to the stock market because of its more conservative asset allocation. And every year, we are saving her over $4,000 in fees by making the switch to index funds.
She was able to benefit from these changes because she consulted with us and allowed us to analyze her portfolio. We invite you to do the same (especially if you are a client of Loring Ward, Edward Jones, or Raymond James). Please call us at (619) 888-4070 for a free consultation. One phone call could save you thousands of dollars every year in fees.
(Posted October 12, 2015)
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Rainier Trinidad, CFA
San Diego and Coronado’s Fiduciary Financial Advisor
Parabolic Asset Management
206 J Avenue
Coronado, CA 92118
Investment Risk Disclaimers: (i) Investments involve risk and are not guaranteed to appreciate, and (ii) Past performance is no guarantee of future results.