I can’t control the markets… but I can control my costs.
For most of my life, my mom, teachers, coaches, mentors…all told me to focus on what I can control. You’ve heard the same messages. They have been part of our culture for centuries.
“Freedom is the only worthy goal in life. It is won by disregarding things that lie beyond our control.”
– Epictetus (1st century A.D.)
“Incredible change happens in your life when you decide to take control of what you do have power over instead of craving control over what you don't.” – Steve Maraboli, Life, the Truth, and Being Free (1999)
When it comes to investing, almost everything is beyond our control. Interest rates, global trade policies, the price of commodities, changes in governments, the impact of weather on crops, you name it… all factors that can affect our portfolio returns. And all of them are beyond our control. But one thing is within our control: the fees that we pay for our asset manager’s services.
Another common adage that I heard growing up was that you get what you pay for. In many cases that is true. High-end furniture is commonly made from more expensive and rare materials. The hand-made craftsmanship can cause a single chair to take days or weeks to build. This time, effort, and skill are rightly reflected in the price. But many studies have shown this is not the case with asset managers. Martin Gruber’s 1996 study found that high fees were actually associated with lower performance. In 2011, Gruber and Edwin Elton combined on another study: it showed that while some active managers could outperform a passive investment fund, the fees that they charged lowered overall returns. Suppose, for instance, that an active manage outperforms the passive index by 0.8%—but then charges 1.5% in fees. The net effect for the investor is negative.
Over time this difference matters.
Let's say you have an investment of $10,000 and it earns 6% before fees. Here’s how fees affect the balance after 25 years: Take two asset managers; one who charges 1.50% (a typical investment manager) and another who charges 0.35% (AssetBuilder’s average fee). If you invest with a typical fund manager, then you will keep approximately 66% of the actual returns from your investments. This translates into a return balance of approximately $64,673 from the original investment. Now, if you had the same performance over the same period of time but only paid 0.35%, then you would retain almost 91% of your returns. This means that your return balance would be approximately $89,285. This difference of almost $25,000 is entirely due to the difference in fees and the compounding effect of the higher fees.
Let’s assume that a costlier advisor is providing better returns. If that were true, then we need to determine how much greater the returns would need to be to have the same return balance of $89,285 net of the higher fees.
Would you believe that the higher paid advisor would have to earn slightly more than an 11.2% return to make up for the additional fees over the years? That is nearly double the 6% hypothetical return for our original portfolio.
Keeping costs low is one of our core values at AssetBuilder. To see how lower fees might affect your portfolio contact our advisors or to see what portfolio is right for you click below.