In yesterday’s post I showed how the stock market’s tendency to rise steadily gets lost in the day-to-day volatility of the market. In a similar way, the drain of investment fees on a portfolio can get lost in the daily choices made by money managers.
Let’s suppose that Sam has his money in mutual funds with an average Management Expense Ratio (MER) of 2.5% per year. This works out to about 0.01% per trading day throughout the year, a seemingly trivial amount.
On any given day, a money manager could make a choice that makes a 5% difference to Sam’s portfolio. This is 500 times bigger than the day’s MER. This is like worrying about an extra nickel on the price of a case of beer.
The problem is that this 5% difference the money manager makes could be either up 5% or down 5%. Over the course of a year, the good and bad choices tend to balance out somewhat, and the 2.5% MER starts to look significant compared to the money manager’s performance.
Over 30 years, the MER has consumed more than half of Sam’s portfolio, and it is highly doubtful that the money managers have consistently performed well enough to justify taking half of Sam’s money. He would almost certainly have been better of investing in low-cost index funds.
Let’s leave the world of percentages and talk about dollars. Suppose that Sam’s portfolio is worth $500,000. Most investors don’t have this much, but they hope to have this much or more before they retire.
The MER Sam pays works out to over $1000 per month. Are Sam’s investment advisor and the managers of his mutual funds really earning $1000 per month working for Sam? It seems doubtful. For this price, Sam could pay a top-notch financial advisor by the hour for half a day each month, not that he should need this much help. Sam could reduce his costs to about $100 per month with low-cost index funds.