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  • Writer's pictureSteve

A Dropped Request

We've been talking a lot about fees the last few months. To wrap up the conversation, I wanted to take a moment and provide a real world example of analyzing fees and returns on investments. A few years ago, I was meeting with a client who brought up the fees associated with the bond funds in her account at the time. She requested we exchange the funds for different ones with lower fees. She made no mention of unhappiness with the performance of the funds. After listening to the request, I first thanked her for the question. I'm always thankful when clients engage in the financial planning and investment management process. Then I provided my thoughts and analysis. In general, while I generally agree lower fees are good and as a firm we strive to always meet that criteria, what we strive for above anything else is to get our clients the highest total return in their accounts after all fees have been considered. What became clear to me after our interaction was that she had run her portfolio through a free online portfolio analyzer. I knew because I've run my portfolios (which look just like yours) through these engines myself and had the same results spat back to me. Unfortunately, these tests only look at fees, they don't look at all at performance, and, as we've discussed, isn't that what investing is about, in the end? Turns out the two bond funds in her portfolio at the time had fees of 0.75% and 0.79% per year. One fund paid 4.56% in interest payments each year and the other paid 5.07%. There was also capital appreciation (or loss) to consider. This is simply looking at price per share over time. One fund's share price was down 0.01% and the other's up 2.57% at that point in the year. These numbers were after fees. If we assumed nothing happened the rest of the year, the client would have made 4.55% on the one fund and 7.64% on the other (again, after fees). Next, I compared it with the "low fee" bond fund recommended by the analysis engine (a fund that's fees were 0.05%/yr - fantastically low!). The fund paid out just 2.34% in interest payments each year to its holders and its share price had appreciated 1.41%, for a total return (assuming no change in share price the rest of the year) of 3.75%. Of course, this was much less than both of the funds I had been using! When I showed all this to the client, she promptly dropped her request. In the end, recall that I get paid for investment management based on your account value, so my interests are that your account value increase. You might think of it this way, too-- if you went camping in the winter, would you rather have a Walmart made tent, or one from the North Face? I like to save money as much as the next guy, and so sometimes I buy from Walmart. But other times spending a little more is worth it if the quality of product (i.e. end result) is much better. In the case of the bond funds mentioned above, the numbers certainly bore this out. One final note as we think about the future. The push to low fee funds is now fairly mainstream. While Wall St. fought it for a long time, they're coming on board now. Schwab recently announced a no fee fund. That's right, no fees! They later retracted the announcement, but the story illustrates the point all the same. Wall St. will sell what the public wants to buy. If all the public cares about is a sticker that says "low/no fees" Wall St. will make it. Never mind the quality of the product, as long as the cost is all that matters, you'll find plenty of opportunities to buy more. This all reminds me of a book I used to read to my children, "10 Apples Up on Top." In it, the characters try to best one another balancing an ever increasing number of apples on their heads. "You can do three? But I can do more! Look, see, I have four!" Investment funds are doing their best now to lower fees, besting one another constantly. I can't help but wonder if the end result will be similar to the book's.... a big mess!

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