The "Sure-Thing" Investment
There is something you can do to make your investing more profitable. It's neither difficult nor complicated, and does not involve any increased risk. However, it does require you to take action, and for some people, that's too much to ask. But if you are a serious investor, if you are saving money for your retirement, or if you are accumulating money so you can enjoy some of life's many pleasures, then taking this simple step can indeed make a difference.
To make the value of your investment nest egg worth significantly more in the future, all you have to do is reduce your expenses. It's very important to bear in mind the fact that the expenses associated with investing play a very important role in determining the overall success of your savings and investing program over any extended period of time - not overnight nor in one year. But if you are attempting to accumulate wealth over the years with a savings program, then the importance of reducing your costs cannot be overemphasized. But before discussing specific steps you can take, let's decide if cutting expenses is really worthwhile for you.
How much difference does a slight reduction in costs make over a lifetime of savings? Let's take a look at the situation from the perspective of a mutual fund investor to see the effect of a small annual cost reduction. According to the Investment Company Institute, the average mutual fund charges 1.25 percent of your assets each year to manage your money. The most expensive exchange traded funds (ETFs) and the largest index fund, the Vanguard 500 Index Fund Investor Shares, charge only 0.18 percent - which is only 18 cents per $100 of invested capital in annual fees. So if you want to invest in mutual funds then indexing clearly is the smarter choice when you consider the expenses.
Something else to consider when it comes to expenses. However you have your savings invested, the less the return on your investments, the more important it is to reduce expenses, and mutual funds are not bashful about taking their fees, and the charge is imposed regardless of how well or how poorly the fund performs.
Let's look 15 years into the future and compare how much less your savings will be worth if you opt to own shares of a traditional mutual fund and pay 1.25 percent rather than shares of an index fund. Based on an initial investment of $10,000 over a 15-year period, you would pay more than $12,500 in fees to the team that actively manages your mutual fund. But if you owned the same number of shares in an index fund (or ETF) instead, you would pay less than $2,000 during the same period of time. And when you consider that it's likely that the mutual fund manager you select is going to underperform the market averages - and that's before management fees are deducted from your account - it makes it that much more important to consider investing your money in low-cost funds.
By investing in shares of index funds, you can cut expenses even further because index funds are managed passively. They don't spend any time or money on costly research in an attempt to beat the market. Index funds attempt to mimic the performance of a specific market segment, not beat it. Index funds seldom change their holdings, doing so only when the composition of the index they are mimicking changes. Because actively managed funds trade often and incur significant commission costs, index funds are more efficient to manage. And on average, index funds perform better than actively managed funds.
ETFs are exchange traded funds that operate like index funds with fees that, in general, are slightly lower than those of index funds. That makes them suitable investment choices for most investors. But these funds trade on an exchange, and although there are no loads, the investor must pay a brokerage commission to buy or sell shares. Thus, ETFs are suitable investment vehicles for anyone who pays very low trading commissions to a deep-discount broker.
There are more ways to cut expenses than by simply chosing a less-expensive mutual fund. The next obvious place to save money is by cutting trading expenses, and that means brokerage fees. Full-service brokers serve a purpose and are the correct choice for many investors. They provide guidance, make recommendations, and answer questions, and if those services are valuable to you then by all means maintain an account with your full-service broker. But if you make all your own investment decisions and don't need those extra services, why pay higher commissions?
All brokers are not alike. Even among the deep discounters, both commissions and the quality of service vary. So don't consider commissions as the only factor when choosing a broker. Trade execution should be your primary concern, as more dollars can be saved by quick, reliable trade execution than by getting poor execution at low rates. By all means save money on commissions, but be certain your orders are filled at good prices.
When making investment decisions for the long term, it makes sense to give yourself the best chance of success. And whenever you reduce costs, you jump-start your savings program. So if you own mutual funds, then get on board an index fund or an ETF instead.
Unless you choose to buy Treasury bonds or certificates of deposit, you never know the rate of return to expect from your investments. But by beginning with an edge - by knowing your costs have been reduced by more than one percentage point per year - you are ahead of the crowd and on a path, with an increased probability of becoming a successful investor.
* * * * *
To make the value of your investment nest egg worth significantly more in the future, all you have to do is reduce your expenses. It's very important to bear in mind the fact that the expenses associated with investing play a very important role in determining the overall success of your savings and investing program over any extended period of time - not overnight nor in one year. But if you are attempting to accumulate wealth over the years with a savings program, then the importance of reducing your costs cannot be overemphasized. But before discussing specific steps you can take, let's decide if cutting expenses is really worthwhile for you.
How much difference does a slight reduction in costs make over a lifetime of savings? Let's take a look at the situation from the perspective of a mutual fund investor to see the effect of a small annual cost reduction. According to the Investment Company Institute, the average mutual fund charges 1.25 percent of your assets each year to manage your money. The most expensive exchange traded funds (ETFs) and the largest index fund, the Vanguard 500 Index Fund Investor Shares, charge only 0.18 percent - which is only 18 cents per $100 of invested capital in annual fees. So if you want to invest in mutual funds then indexing clearly is the smarter choice when you consider the expenses.
Something else to consider when it comes to expenses. However you have your savings invested, the less the return on your investments, the more important it is to reduce expenses, and mutual funds are not bashful about taking their fees, and the charge is imposed regardless of how well or how poorly the fund performs.
Let's look 15 years into the future and compare how much less your savings will be worth if you opt to own shares of a traditional mutual fund and pay 1.25 percent rather than shares of an index fund. Based on an initial investment of $10,000 over a 15-year period, you would pay more than $12,500 in fees to the team that actively manages your mutual fund. But if you owned the same number of shares in an index fund (or ETF) instead, you would pay less than $2,000 during the same period of time. And when you consider that it's likely that the mutual fund manager you select is going to underperform the market averages - and that's before management fees are deducted from your account - it makes it that much more important to consider investing your money in low-cost funds.
By investing in shares of index funds, you can cut expenses even further because index funds are managed passively. They don't spend any time or money on costly research in an attempt to beat the market. Index funds attempt to mimic the performance of a specific market segment, not beat it. Index funds seldom change their holdings, doing so only when the composition of the index they are mimicking changes. Because actively managed funds trade often and incur significant commission costs, index funds are more efficient to manage. And on average, index funds perform better than actively managed funds.
ETFs are exchange traded funds that operate like index funds with fees that, in general, are slightly lower than those of index funds. That makes them suitable investment choices for most investors. But these funds trade on an exchange, and although there are no loads, the investor must pay a brokerage commission to buy or sell shares. Thus, ETFs are suitable investment vehicles for anyone who pays very low trading commissions to a deep-discount broker.
There are more ways to cut expenses than by simply chosing a less-expensive mutual fund. The next obvious place to save money is by cutting trading expenses, and that means brokerage fees. Full-service brokers serve a purpose and are the correct choice for many investors. They provide guidance, make recommendations, and answer questions, and if those services are valuable to you then by all means maintain an account with your full-service broker. But if you make all your own investment decisions and don't need those extra services, why pay higher commissions?
All brokers are not alike. Even among the deep discounters, both commissions and the quality of service vary. So don't consider commissions as the only factor when choosing a broker. Trade execution should be your primary concern, as more dollars can be saved by quick, reliable trade execution than by getting poor execution at low rates. By all means save money on commissions, but be certain your orders are filled at good prices.
When making investment decisions for the long term, it makes sense to give yourself the best chance of success. And whenever you reduce costs, you jump-start your savings program. So if you own mutual funds, then get on board an index fund or an ETF instead.
Unless you choose to buy Treasury bonds or certificates of deposit, you never know the rate of return to expect from your investments. But by beginning with an edge - by knowing your costs have been reduced by more than one percentage point per year - you are ahead of the crowd and on a path, with an increased probability of becoming a successful investor.
* * * * *
posted by Bob Moser at
8:36 PM
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