If what you thought to be true turned out not to be true, when would you want to know that? Would it disturb you to discover that you probably are (unknowingly and unnecessarily) paying more than 6% in your investments each and every year (which is almost like betting against one of the most powerful forces in the universe, the power of compounding)? Before inflation? Before paying advisory fees?
Well unfortunately this may disturb you
Few of us ever read a mutual fund's (MF) or exchange traded fund's (ETF) prospectus, which reveals the Net Expense Ratio (NER). That is normal. It is filled with "legalese", in small font, and is ever so boring.
According to Morningstar the average stock mutual fund NER has risen (sneakily, but ever so steadily) from 1.39% in 1987 to over 1.52% by October 2010; and that number may continue to head toward 2%. Higher still are "small cap" funds NER of 1.61%, international funds - NER 1.68%.
Even fewer of us read the Statement of Additional Information (SAI), which describes the activities and additional fund expenses, costs, and fees. One of the most misunderstood or understated of these is the trading activity within the fund.
Morningstar shows that the average mutual fund has a stock turnover of about 115% per year every year. How is that for activity? That means if there are 100 stocks in a particular fund at the beginning of the year, by the end of the year at least 100 of those same stocks have been sold, then others bought and some of those are sold with yet others boughtoften repeating the same stocks.
The SAI-reports that additional Trading Costs, on average, approach another 1.44% per year (for the period 1995-2005), according to Roger Edelen of Boston College and Richard Evans of the University of Virginia and Gregory Kadlec of Virginia Polytechnical Institute in their article Scale Affects in Mutual Performance reported in a 2007 Registered RepresentativeMagazine. (And according to fundpolice.com the Zero Alpha Group tracks undisclosed brokerage costs and they calculate the average fund annual expense ratio to be 1.72%*).
Moreover, these trading activities also cause taxable events costing investors to lose on average an additional 2.5% of their returns to taxes on (embedded in the fund) long and short term capital gains (not to mention dividend taxation) each year asrevealed on the SEC website in 2006.
Thus, to determine the true cost of only a mutual fund all these fees must be added together which would make the industry average 4.01 to 5.46% per year, according to Ray J. Shreder, RFC, CRC, AIF.
On top of all that, the average financial advisor fee is 1.41% according Tiburon's Strategic Advisors, the fee-only financial advisors' Best Practices Survey.
On the "My Money Blog" website, Morningstar admits that fund expenses are more important than "star ratings" and this was reported on August 17, 2010. According to Allan Ross of CBS moneywatch.com August 17, 2009 "Mutual fund fees jumped 5%."
Oh, and did we talk about the custodial fees of 0.06 to 0.25% for Schwab or TD Ameritrade or Fidelity or Wells Fargo to hold your assets? Or the cost of trading the funds themselves? Someone has to get paid for that, too, averaging 0.2%.
What does that all mean? Summit's research shows, using outside funds, total costs to you can exceed 4.77%. So your fund must earn almost 5% for you to break even!
What is the solution?
Because of the previous data we're not big fans of ETF's or mutual funds because of these high expenses. Rather, we prefer the institutional structured fund model that complies with the Center for Research of Security Pricing low turnover, low transaction costs, and low trading costs. These funds are not required to buy high and sell low as opposed to most index funds.
Why not ask to get a Free Market Investment Analysis? There are only two possible outcomes: first, everything you are doing is greatwhen would you want to know this? Second, what you are doing is costing you BIGwhen would you want know that? This FMIA includes your portfolio's efficiency, cost analysis, and overlap study.
Copyright (c) 2011 Mitch Levin
Mitch Levin, MD, CWPPtm, CAPPtm, CEO & Managing Director of Summit Wealth - Florida Division, a Registered Investment Advisory firm. Summit Wealth is dedicated to "empowering investors to build, protect, and preserve their prosperity through their own Financial Fortress." For more information about Mitch Levin visit http://www.mysummitwealth.com/
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