Keep Your Money

There's not much that we can control to effect our investments' performance - except for expenses. Pay as little as possible because they can eat up most of your gains. Money that should rightfully end up in our pockets ends up lining fund manager's pockets.

If you’re like most everyone else, you look at the price of something before you buy it. You prefer to buy stuff that costs less. But when it comes to investing, it’s not that easy. There’s not a price tag on a mutual fund. There’s an expense ratio, some abstract number that is nothing close to a price tag that you’re used to seeing every day.

What if you went to your local grocery store to pick up a carton of orange juice and instead of the price tag listed as $2.99 it had some crazy equation like .12 X number of ounces X glasses you’All drink X annual consumption. It would be a lot harder to figure out how much that orange juice is going to cost you. The fund companies love this. They love that you can’t understand how much you’re paying them. Because if you don’t know how much you’re paying them, they can charge you more.

Your fund expenses are mostly wrapped up into an expense ratio. If your fund’s expense ratio is 1.2% and you have $100,000 invested, that means you’re paying your fund company $1,200 dollars a year for that fund. Yes, it’s an annual fee. Yes, you pay it whether your fund does well, or tanks.

More cryptically, you also pay for the expenses when stocks within the fund are bought and sold. For actively managed funds (bad) this can be a considerable amount. The fund’s turnover ratio lets you know how often stock is bought and sold for the fund. When the fund manager buys and sells stock, there are middlemen who make money. You pay them, but you don’t know it because this opaque charge is not wrapped into expense ratio but just adjusted into the price of the fund.

If you own one share of a fund that is worth $1 today, your fund manager buys and sells a bunch of underlying stock and pays the brokers a lot of money, your part of that bill ends up being five cents. You’re never billed for that. Instead, you still own your own share, but now it’s only worth $0.95. The five cents just automagically disappeared. Another reason to use only index funds.

Try this yourself. Ask your friends how much their mutual funds cost them last year. Not how much they went up or down, but how much they paid to the fund company regardless of the funds actual performance. I have yet to find anyone who knows. You know how much you pay for cable, for electricity, for water. Why don’t you know how much you pay for your mutual funds, especially when it may likely dwarf what you pay for those other things?

Here’s where things get a bit tricky. With investing, what you pay is even more important than when you buy stuff in your everyday life. Because if you pay an extra dollar today to the fund company, that is one dollar that you should have kept that would have grown over the next 30 years. So that one dollar today ends up being $17 dollars that you should have had at retirement.

You pay the one dollar and that one dollar’s growth opportunity. Giving the one dollar away is bad enough, but that one dollar would have had “kids” and his “kids” would have had “kids” and so on until there was 17 of them. Instead, your dollar did multiply, but in the hands of the fund company who stole it from you.

Actively managed funds are run by smart MBAs. Guys with slicked back hair driving their Porsches, thinking they’re kings of the world. They want to get paid for their smarts so they charge you high expense ratios for actively managed funds. And because they want to feel smart, they trade into and out of stocks, trying to beat the market, incurring even more turnover expenses. You foot the bill. And most of the time, they can’t even match the market. Thanks for nothing.

Index funds on the other hand just kind of run by themselves. No cocky fund manager to overcompensate. Like a S&P 500 index fund – just set to automatically track 500 companies. The low expenses of index funds gives you a huge advantage over actively managed funds. Only buy index funds.