This principle has been around for decades, applied to situations ranging from aviation engineering to modern architecture to the animation masters at Disney. Yet, when it comes to investing our emotions tend to distract us from this guiding principle. In fact, if you take a closer look at the mutual fund industry over time you would find that straying away from this concept has proven to be very costly. Since Vanguard was founded in 1974, it has been able to save investors hundreds of billions of dollars directly and indirectly. It has done this in three different ways: lower fees, lower turnover, and the “Vangaurd Effect”. Eric Balchunas details this in his Bloomberg article:
Vanguard has saved investors $175 billion in fees since it was founded in 1974. This is based on the historical difference between the asset-weighted average expense ratio of an active mutual fund versus that of a Vanguard fund, as seen in the chart below. The difference is multiplied by the firm’s assets each year — in other words, the amount an investor would have paid if Vanguard didn’t exist.
The firm has also saved investors about $140 billion in trading costs or turnover. Every time a fund manager makes a trade, it costs a tiny amount. Generally speaking, every additional 1 percent in turnover comes with 0.01 percent in extra costs. Active mutual funds have an average turnover approximately 50 percentage points higher than a Vanguard fund.
Finally, there is the “Vanguard Effect”: The company’s influence leads other funds to lower their fees in order to better compete. For example, the average fee for active funds has dropped from .99 percent in 2000 to .77 percent today, which can also be seen in the above chart. This decline benefits the investors who make up the $10 trillion in active mutual-fund assets. In other words, Vanguard has saved non-Vanguard investors about $200 billion in active funds alone.
From this it is easy to see how one can best control costs by using a low-cost, passive mutual fund. This may feel counter intuitive by doing less, but this allows you to do more. More focus on the proper asset allocation for your risk level, more time spent on your financial planning and (most importantly) more money towards your portfolio instead of towards fees. The global market’s movement day-to-day is far too complex to try to predict. Instead we should simply focus on the things we can control: fees, diversification, taxes and discipline (rebalancing). Keeping to a more simplistic investment focus has shown to be more rewarding, as well as a much more effective use of our time.
If there was still any doubt that brokers have been selling clients products that aren't in their best interest, this should put it to bed. An article in Financial Advisor magazine reported the following:
Through August, sales of non-traded REITs were $3.15 billion, down 55 percent from the same period a year ago, according to the Robert A. Stanger & Co., which tracks the industry.
Sales of BDCs through August were $1.07 billion, down 62 percent.
Non-traded REITs, the bigger category, should reach around $5 billion this year — about half of last year — said Keith Allaire, managing director at Stanger.
What are non-traded REITs and BDC's you ask? These are products with high commissions and fees (sometimes over 15%) with countless examples of massive blowups. In this day and age with Google, it is hard to believe they still exist in their current form. Just google "non-traded REIT scam" you'll find over 17,000 hits with the first few links being stern warnings from the SEC and FINRA. The old adage that these products are "never bought but sold" is entirely correct. You almost exclusively see these products sold by brokers. So, what is the reason for the massive drop-off in sales? The article states it pretty clearly:
"That's primarily due to the change from full front-load structure, to a trail commission structure," he said. "It's a matter of getting new products in the pipeline, and at B-Ds trying to figure what structure they want on the platform."
Translation: cut out the big commissions and brokers won't sell it anymore. This goes to show you that little concern was given to the quality of the product (anyone looking closely at these things knew that a long time ago) or the client. The appeal of these products was always about the huge upfront commissions. With the advent of the Fiduciary rule, requiring all brokers advising retirement accounts act in the client's best interest, it seems like some of these horrible products are seeing asset flows dwindle. That's a great thing for consumers.
If you are in the market for an advisor, I urge you to find one that always acts in your best interest (not just for retirement accounts) so you can avoid situations like this. The best way to find one is through the National Association of Personal Financial Advisors (www.napfa.org). While you aren't guaranteed to find a great advisor (you still need to vet them further), at least you will know that advisor is not incented by selling you products (NAPFA members cannot accept commissions or kickbacks in any form).
Full disclosure- Greenspring is a member of NAPFA.
Nearly one-hundred years ago one of the best (and worst) barters occurred in New York City. I read the entertaining story recently and found it fascinating. While it is a great tale of American history, the message is wholly relevant to investors today:
Described by The New York Times as "one of the finest" residences in the area, the Plants' New York City residence was on the corner of 52nd Street and Fifth Avenue. It was built in an Italian Renaissance style of limestone with marble accents.
When Maisie Plant fell in love with the natural, oriental pearl necklace, Pierre Cartier sensed an opportunity. Pierre, the savvy businessman, proposed the deal of a lifetime: He offered to trade the double-strand necklace of the rare pearls — and $100 — for the Plants' New York City home. The necklace was valued at $1 million, while the building was valued at $925,000, according to The New York Times.
The pearls were worth more than the Mansion at the time. Why were the pearls so costly? Cultured pearls had not fully entered the marketplace yet, which meant that each natural pearl had to be found by divers. It had therefore taken Cartier years to assemble the 128 graduated, perfectly matched pearls of Plant's necklace. Additionally, diamonds were becoming less valuable because of recent discoveries in Africa. Because of their rarity, natural pearls had become the symbol of the well-to-do socialite.
Maybe it's the way my brain works, but I wanted to find out who really made out in this deal, and to what extent. Below are the values of what the trades would be worth today. In doing some further digging and research, I found the following info:
- In 2004, a similar natural, double-strand pearl necklace sold at Christie’s for $3.1 million. This is a 1.1% annual return over time (much worse than inflation)
- The 5th Avenue mansion is listed in NYC tax assessments at $52 million (probably much less than what it is actually worth). This is represents a 4.2% return over this time period.
Sadly, Ms. Plant's heirs sold her necklace after her death at auction for a mere $170,000 in 1957 (a loss of 86% from her purchase price). So, Cartier was the winner in this trade. What is not even mentioned, is that for the past 97 years, the 5th Avenue building also was producing income (via rent) which makes its true value hard to even quantify over time. This is just another example of why we tend to shy away from commodity type investments like precious metals. They cannot grow, cannot produce income and your returns come from the hope that someone else will be willing to pay more than you did.
Just in case you were wondering, over the same time period, stocks would have turned the same investment into $271 million (without accounting for dividends)! Just another example of the power of investing in businesses and not just hard assets.
Information contained herein has been obtained from sources considered reliable, but its accuracy and completeness are not guaranteed. It is not intended as the primary basis for financial planning or investment decisions and should not be construed as advice meeting the particular investment needs of any investor. This material has been prepared for information purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Past performance is no guarantee of future results.