The Real Cost of Low-Fee Funds

The Real Cost of Low-Fee Funds by John Mauldin – Mauldin Economics

Today, rather than tackle some big macroeconomic issue, we’ll go back to this letter’s roots and look at market timing and portfolio construction issues. I expect this will get both enthusiastic support and at the same time, make a number of readers uncomfortable—if not annoyed.

Why? Because I am going to take on a number of shibboleths many hold sacred and dear. But after a great deal of thought over the last few years, I’ve come to realize that all too often, and this includes myself, investment advisors and investors tend to “talk their book.” We bring prejudices and biases into our portfolio construction, and then if it doesn’t work, we just call it “bad luck.” Let’s jump in.

The Real Cost of Low-Fee Funds

I wrestled with the title for this letter because I could’ve substituted the word high or true or hidden for the word “real” in the headline and just as easily have described my thesis. Low-fee funds, used the way that they are generally used, have hidden costs investment advisors don’t want to discuss and investors ignore.

Other things being equal, lower fee funds are better than higher fee funds which do the same thing. That is obvious. The total returns of lower fee funds over time are mathematically precise on this.

Yogi Berra, although he may not have been the first to say something similar, popularized the quote, “In theory, there is no difference between theory and practice. But in practice, there is.” That also applies to low-fee funds.

If you are using an investment advisor, you pay advisory fees plus fund and custodial fees. If you are an individual investor running your own account, you are paying the fund fees plus the custodian or platform fees. It makes sense to pay as little as you can for those services.

If you use those low-fee index funds (like ETFs) as trading vehicles, that is particularly good advice. But that is not the way the vast majority of low-fee funds are used.

You Must Include Risk When Calculating Total Cost

Most low-fee funds are part of a “buy-and-hold” management strategy. Investment advisers say we are “investing for the long run,” and diversify among low-fee funds in various asset classes and indexes. They trot out studies showing that over the long run, investors will average 8% or whatever.

And those are true statements, but most investors don’t have the 40 or 50 years those studies were designed for and so have to experience the bear markets along with the bull markets. The studies can be misleading, too, depending on when they start. They generally don’t tell you that the market can be in a bear cycle for 20 years before recovering.

That is all well and good in a bull market, but in a bear market, you are simply diversifying your losses. While it may be tax efficient, in a bear market, you simply end up with tax efficient losses.

We are now in one of the longest running bull markets in history. However, it is not clear if this bull market will continue for a few more years, roll over into a much larger correction, or maybe churn sideways for an extended time. No one knows the future.

But I do know this: We are eventually going to have a recession and the accompanying bear market will be brutal, as all bear markets are during recessions. I don’t think there has been, at least that I can find, a serious bear market that doesn’t accompany a recession. You can find corrections like 1987 or 1998 that weren’t associated with recessions, but as we will see below, those should perhaps be treated differently.

I think the next recession will likely see a bear market loss of at least 40% if not 50%.

As I’ve demonstrated elsewhere, high total US debt means the recovery will be even slower this time. If you are over 55 or 60 years old, your “investing for the long run” could end up seriously impacting your retirement income. Or push your retirement off for years as you try to make up by saving what you lost in the bear market.

And the investment advisor or strategist who told you to use a buy-and-hold strategy will simply shrug it off and say something like, “I am sorry. But we can’t predict the markets. It’s just bad luck we had a recession and bear market.”

Continue Reading / Mauldin Economics>>>

Sharing is caring!