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July 02, 2010

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I don't do any of those. Sweet!

The only thing I could be guilty of is number 6. I usually get back 1-2k each year. That's not exactly "overpaying", it's over withholding.

Expensive mutual funds are a common one for people. However, ETFs are going to be a better bet than even low cost mutual funds. Many brokerages, vanguard included, are dropping trade commissions on most ETFs so now. For example the Vanguard Total Stock Index ETF is a mere .07% compared 0.18% or just a little over 2 1/2 the cost. Will #1 change from expensive mutual funds to just mutual funds instead of ETFs? Only time will tell I guess

Depends on how ETFs are used and what your balance is....

For example, if you only contribute $100 a year, the ETF's trading fees represent a huge % in cost as opposed to if you contribute $5000 each year.

Also, it depends on your contribution style. For example, if you have a 401(k) and it contributes bi-weekly or monthly, that trading fee can be fairly substantial as opposed to someone who manually makes an annual lump sum trade.

And that's also assuming we're only talking about one ETF. The trading costs apply per trade. So, if you slice & dice your own ETF portfolio, you're going to have at least one large cap ETF, one bond ETF, and perhaps one international ETF. So, your trading fees may add up to more than expected.

The point is, while ETFs CAN be cheaper, it's not always the case

In my opinion one should zero in on fund performance and NOT fund management costs.

I only own two mutual funds at this time, my other holdings are CDs and Municipal Bonds.

Compare SXFIX (Wells Fargo muni bond fund) with MUB (Barclay's Muni Bond ETF)
Annual return YTD for SXFIX is 8.13% ...... Fund annual expense 0.8%
Annual return YTD for MUB is 5.97% ......... Fund annual expense 0.25%

Compare PGNDX (Pimco Mortgage backed securities fund) with MBB (Barclay's Mortgage backed securities ETF)
Annual return YTD for PGNDX is 13.21% ....... Fund annual expense 0.9%
Annual return YTD for MBB is 10.15% ........... Fund annual expense 0.25%

I add to both funds about a couple of times per month when I reinvest the interest from my CDs and muni bonds which come in at various times, some monthly, some semi-annually.
My two mutual funds are both NTF i.e. no transaction fees thus it costs nothing to buy more shares.
For the two ETFs I would be charged $8 for each trade which amounts to another $384/year for 48 trades.

Since I have large six figure amounts in each fund as you can see I am well ahead of the game by using two of the best in their class, actively managed NTF funds rather than ETFs which only try to match bond indexes.

Thus in these two cases it is untrue that ETFs are a better choice than the best actively managed funds of the same type.

It costs more to have a team of very experienced fund managers managing a very large and diversified portfolio of real bonds compared with a far less experienced person that only has to use a simple approach using other financial instruments to follow an index rather than buying and selling real bonds every day.
In my two examples the added management costs of actively managed funds are insignificant compared with their greater performance.

Another major problem with some ETFs is that they are thinly traded and if you are dealing with large amounts of money then the lack of liquidity can result in excessive volatility. Actively managed funds however are only priced once/day at 4pm EST.

Overpaying on a mortgage can be a great thing to do in some cases.

Let's say that you are a lot better off now than when you took out your 30 year mortgage a few years back and you now would like to send in two payments/month instead of one then the mortgage companies that I dealt with years ago would take the amount of that second payment right off the unpaid principal. Thus you could really hasten the time to when the mortgage was fully paid off and save yourself lots and lots of interest in the process.
This would be particularly good if interest rates have gone up in the meanwhile and it would not be a good idea to refinance your low interest rate 30 year mortgage into a new 15 year mortgage at a much higher interest rate, as well as having to pay all the extra fees and points associated with obtaining a new mortgage.

Old Limey is correct. Costs of a fund are only one part of the analysis. Focusing on cost at the expense of performance is a major error. There are a number of low cost funds that under perform their benchmark by more than the cost of better funds.

Old Limey and Tyler --

I don't think anyone (me, the piece quoted, or any other reasonable person) is suggesting that people abandon looking at return as well as costs. After all, everyone is interested in total return -- the return after costs, taxes, etc.

While we all can offer examples of funds that have higher costs and yet greater total return, there are many, many, many more examples of costs dragging down good returns so that their total returns end up below those of "lower performing" funds. It's a key reason why so many index funds beat comparable actively-managed funds. The actively managed funds might do better in gross return, but are then killed with costs that makes their total return well below that of index funds.

So of course you can't ignore either costs or return. But so many "average" investors look just at gross return that this piece (and me) is pointing out that costs (and hence total return) need to be considered when evaluating the performance of investments.

Old Limey - Your comment about overpaying on mortgage is what I thought at first, also. But if you click through to the original article for the explanation of point #4, they are talking about paying too high of an interest rate on a mortgage (i.e. not refinancing to get a lower interest rate).

Yeah, ok, I can buy the argument that fund performance are the most important thing, since that's what we're all ultimately after.

However, cost is the only factor that is within the controllable domain of the investor, whereas the fund performance is not.

Cost also plays a direct role in our net fund return, which is what I would think is the most important of all.

So yeah, I would look at both, but the only decision we can make on it is the cost.

FMF:
With so many funds available (both ETF and actively managed), for someone like me that has always strived to outperform the market it is essential to be able to examine the performance of all the funds that are available to me in any category that I am interested in. I have the distribution adjusted data and the analytical tools to be able to compare individual funds over any period that I want. I look at total return, volatility, risk adjusted return, and maximum drawdown and pay no attention whatsoever to fund expenses other than of course I would only consider no-load funds.
Only if a person does not want to go to the trouble that I go to does it make sense to make a fund's expense ratio a major selection criterion since total return obviously includes fund expenses. In the years when I only invested in no-load equity funds I traded frequently and seldom did I hold a fund as long as 6 months. The strategy was to find the fund with the strongest upward momentum, ride it up until it faltered, and then jump on another one that had the strongest upward momentum. Some funds had higher expenses than others but there were usually reasons why. Often the international and emerging market funds incurred currency transaction fees that domestic funds did not have. Also finding the strongest performing companies required a lot of expensive research by fund companies. When you are content with matching a broad index you are settling for mediocrity, that was not my style in my younger days. By definition, an index is usually a weighted average of hundreds of items in the index, some great, some awful. Until I reached my financial goals I never settled with average performance. These days however I no longer need to take risks which is why I own nothing that holds a single stock and am enjoying a good year.

Old Limey --

I think we've been through this before. ;-)

For reference:

http://www.freemoneyfinance.com/2010/05/why-i-invest-like-i-do.html

http://www.freemoneyfinance.com/2010/02/is-it-possible-to-beat-the-market-.html

FMF:
In the two links that you refer to I stated that I was able to manage my investments the way I did because, being retired, I had lots of time, I also had excellent math skills, and access to some great software for performing fund selection and market timing. When I was working, my job was my primary focus and for me it would have had to be one or the other - I am not good at multi-tasking.
However there are a huge number of market advisory services and financial advisors available that actively manage their clients' portfolios, either for a fee or a percentage of any gains. Choosing one is the big problem because they seldom tell you about their past history. Friends of mine that use an advisor are very reluctant to discuss results. If you search on "The Hulbert Financial Digest" you will come across a well known monthly service that has ranked the actual performance of over 180 newsletters since 1980. In the 80's, before I retired I read Hulbert's Financial Digest at my local reference library in order to find out who the best rated stockpickers were at that time because I thought I would put a small amount of money into stocks to see if it worked out. I subscribed to the two best stockpicking services for several months but was quite disappointed in the results. I think the delay between when the letters were written and when they arrived in my mailbox when I got home from work was the problem, the information was frequently several days too late to be of real use. That's the first and last time I paid for advice.

I try to balance index fund investing with investing in dividend growth stocks, if only to keep it interesting and to motivate myself to keep investing when index funds get dull.

First of all, I don't make those mistakes - thankfully. Having said that, #3 jumps out at me. The idea that monthly payments relate to affordability is reflective of an underlying, flawed view of personal finance in my opinion. I realize that not everyone will see it that way.

The inability to distinguish between wants and needs, along with a lack of understanding of the importance of saving a healthy portion of one's income, is what derails too many people and inhibits their ability to achieve some of their dreams.

On a related note, I was at the local mall today, and saw a new discount home decor place - with most items under $300 - having a sign posted that said: "We offer Layaway". Remarkable!

For the first few months that I had a credit card I was happy to pay the minimum amount - I thought it was great! Then I realised I was paying more in intrest to the credit card company than I was for my gym membership! Over the next few months I paid off the credit card in full. So now, every penny I spend helps me and not the credit card company. Because of this, I think that point 7 is absolutely right!

ETF
Wow! Point #7 is not merely absolutely right - It's an obvious No Brainer!

Most of my investments are in ETFs. I like the fact that the expenses are so low, lower even than most index funds. Yes, there are trading fees each time you buy and sell. However since I am under 30, and not planning to sell anything for at least 30 years, it should balance out.

Rob:
ETFs are fairly new in the investment world but since the ones I am aware of track an index then the index would give you an idea of how to estimate their probable track record if they had been around.

The 10 year record for the US Total Stock Market Index is a negative 2.43% annual rate of return, total loss 21.77%.
The 20 year record for the US Total Stock Market Index is a positive 5.84% annual rate of return, total gain 211.13%.
My data starts on 9/1/1988 so I don't have the 30 year record..

I would think that for someone like yourself that is not going to actively manage your own retirement account the best choice for a single fund would be one of the Target 2040 funds. They are not ETF funds but Fidelity Investments and T Rowe Price, and probably others, have such funds.
These funds vary the balance between bonds and stocks throughout the 30 year time period based upon some commonly used ratios. In other words, they start out aggressively and then become more conservative as you get closer to retirement age, because you don't want to take a big hit when you are close to needing the money.
Good Luck! I hope the next 30 years work out well for you.

"We Make Every Day" - who buys mutual funds or makes credit card payments EVERY DAY??? it could have been worded as regularly or every noe & then or even every month, but that might not be as exciting as this tag-line - even if it is bogus...

Rob,
Have a care about not selling anything for 30 years. (If I am misreading your comment, sorry) It sounds like you are 'Marrying your ETF's". As a former/current 'buy and holder' fan, the coming 30 years are shaping up to be different than the last 30. And though I view myself as a buy and holder, I did review and if need be reallocate my fund holdings. Even selling all of a fund if I didn't like it's history or other factors came to my attention. (All this was done inside a taxed deferred account so there were no tax consequences and no transaction costs.

We all know and recite the mantra: Past performance is no guarantee of future performance. But it is especially true now. The market recovery from the Panic of 2008, along with the debt/stimulus hangover is going to take 5 to 10 years.
And I am an optimist on the USA.
I'm not one to say money can't won't be made, just that recoveries from financial recessions are a different breed. Investor attitudes are going to be different. (for example the panics of 1873
and 1929). And a roller coaster ride is ahead for all of us.

As far as Target date funds, I have to admit I am skeptical of them. From what I read, a number of them did not do what they should have been doing based on the target date. Sorry no examples to cite.

All I am really trying to say, is one can't invest in the market and then just forget about the investments. (Unless you get lucky and but the next Bershire Hathaway)

Godd luck to you, and to us all.

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