How The Hidden Fees Of Mutual Funds Hurt Your Portfoliio

In this episode, I share how a recently widowed friend of mine was told by a large investment firm that her money would last until she was 93 years old. She’s 61 now.

How did they figure that? Well, they ran a Monte Carlo analysis of course! And if the Monte Carlos says you are good to go, well, who’s going to argue with that?

I do! The three things that must be looked at when it comes to the Monte Carlo are:
1. Rates of returns the software is using
2. Investment fees
3. Taxes

I go into detail of all three in the podcast. But, if the software from which the Monte Carlo is based is saying cash will return you 3% and a conservative portfolio (20% stocks / 80% bonds) 6.2%, that is way overly optimistic in a world today when the 10 yr Treasury bond is paying all of 2.80%.

How about investment fees? Investment fees that run say 1% will eat approximately 25% of your total returns on a more conservative portfolio. That needs to be addressed in your Monte Carlo analysis too.

Oh, you don’t pay a money manager but instead have mutual funds? Are there NO fees on your funds?

Ever hear of taxes? Well, if you have the bulk of your assets in qualified accounts like an IRA or 401k, every penny you take out from those accounts is taxed at Ordinary Income.

My widowed friend only needs to generate $37k or so of income before she is in the 22% tax bracket!

Monte Carlo doesn’t take that into consideration either.

What am I getting at? Simple. If a call center employee at a big firm says you’re fine with your retirement projections because he or she ran a Monte Carlo and it says you have an 85% success probability, the first thing you need to do is ask “huh. interesting. What are you using for rates of returns? Are you adjusting for the investment fees you want me to pay? Are you adjusting for the taxes I will pay?”

If the answer is no, which undoubtedly it will be,  you need a second opinion.

If you are not looking at the NET, you could be in big trouble.

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Mutual Funds: everyone owns them. And nowadays, it’s SO easy to analyze them. You can just go to a place like Yahoo Finance – Business Finance, Stock Market, Quotes, News or Morningstar | Independent Investment Research and get an unlimited amount of info, at your fingertips, for free!

The internet has been fantastic for the democratization of the investment world, bringing information to the masses, not unlike William Tyndale translating Bibles.

Mutual Fund Hidden Fees

However, there is one area of mutual funds that no matter the research you do, you will still be in the dark; the actual trading costs a mutual fund incurs.

Try going to the SEC website and look up trading costs for the fund of your choice. You’ll find nothing. Try going to Morningstar. Nope, not there either. Call the fund company maybe? Sorry. They don’t have that information.

Trading Costs Can DOUBLE Your Fees

So, you may be inclined to think that because the information can’t be found, it’s not that important. Well, you’d be wrong to make that assumption. In this video, and the accompanying article from my blog,…, I use research a couple academics conducted that claim trading costs add another level of fees to investors equal to the actual expense ratio of a fund! Think about that. You have a 1% mutual fund expense ratio, but add in trading costs and your total expenses are 2%!

Now, that may not seem a big deal to you. But think about it like this. Let’s just say your fund returns 10% before fees. Well if fees are 2% total, to include trading, costs, your net return is 8%. This means you’ve lost 20% of your gross returns to fees! Don’t forget, fees don’t go away when the markets go down. So, if your fund grossed -10% return, well after fees your NET return would be -12%. Again, it cost you 20% more on the downside and 20% LESS on the up.

Comparing Fund Expenses

Yet, we have no way to measure what Fund A costs vs. Fund B. And that’s not good. So, in the video, I show you how to make an attempt to understand the total costs of your fund. It’s not scientific, but it’s the best we can do at this point. We start by examining “Turnover”.

Now, you may be think a high turnover equals high expense relative to a lower turnover fund. Unfortunately, that may not be the case. The professors examined a $500 million small-cap fund with 50% turnover vs. a $100 million large cap fund with 100% turnover. The small cap fund had more trading costs. However, turnover is a starting point in your analysis. It just isn’t as clear as we’d like it to be.

Vanguard S&P 500 (VFINX)

Looking at Vanguard’s SP 500 Index fund. It has a turnover of 3% and an expense ratio of .14%. It is a HUGE fund, $84 billion of assets. So, when it trades, it’s not cheap. BUT at least you know it doesn’t trade much and has low expenses to match. So, if you have a fund with a huge asset base, high expenses, and high turnover…. well that fund is probably going to cost you.


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