How Much Are Your ETFs and Mutual Funds Costing You?

Perhaps it’s the new Tony Robbins book that has created this stir, but we’ve gotten a lot of calls and emails lately from people interested in using an independent RIA like us. We’ve also had a lot of questions regarding what type of vehicles we use and the fees involved with them (i.e. Operating Expense Ratios [“OERs”]).

We love taking these questions head on. Since day one, we’ve always preached low cost is better. Transparency about fees and costs is integral to our business. As an Accredited Investment Fiduciary, fees are something we absolutely review and use in consideration of any product.

Furthermore, given the math of compounding, we know (and have given seminars on) the huge benefit that minimizing expenses can have on a portfolio over time. See the graph below:

Expense graph 042915














Here are some Frequently Asked Questions:

Do you use individual stocks?

No. Here’s why: it creates unnecessary company-specific risk. Prudent risk management tells us to avoid company-specific risk and diversify.

What vehicles do you use?

Predominantly, low cost mutual funds and Exchange-Traded Funds (“ETFs”) within our Core Equity and Core Fixed Income models.

Why do you use mutual funds and ETFs?

Each mutual fund and ETF within our Core Equity and Core Fixed Income models provides inexpensive exposure to an underlying basket of securities, hence, providing the investor with great diversification to the multiple market exposures we think an investor needs. These include markets such as large cap, mid cap, small cap, international, emerging markets, investment-grade bond, high-yield bond, floating rate bond, international bond, etc.

How can you tell if a mutual fund/ETF is expensive or not?

Check out their Operating Expense Ratio, which can be found in their prospectus or on Morningstar or Yahoo Finance. OER includes costs such as portfolio management, operating expenses, distribution, and administration. There are some exceptions, but typically an OER under 0.50% is pretty cheap and an OER over 1.5% is pretty expensive.

You said your Core Models are inexpensive. How inexpensive are they?

Our Core Equity model has a weighted OER of 0.34% and our Core Fixed Model has a weighted OER of 0.37%. That compares to the average 1.31% paid to the US stock mutual fund. That is almost 1% in savings. Take a look at the graph above to see what a difference that 1% can make over time. Like Tony Robbins said in his “Money: Master the Game” book: “By simply removing expensive mutual funds from your life and replacing them with low-cost index funds you will have made a major step in recouping up to 70% of your potential future nest egg! How exciting!” How exciting indeed!

I heard ETFs are cheaper than mutual funds. Is that true? 

It’s not black or white. The real question is whether the security (i.e. mutual fund or ETF) is utilizing passive or active management. With active management, there are a lot of added costs: a portfolio management team, traders, rent, etc. Passive management typically follows an index which means a lot of those “active” costs don’t exist. Hence passive management is cheaper.

Most, but not all ETFs, follow a passive management approach. Many, but not all mutual funds, follow an active approach. But that doesn’t necessarily mean that all mutual funds are expensive and all ETFs are cheap. In fact, the mutual funds we utilize in our Core Equity and Core Fixed Models are the ones that follow a passive approach and therefore are just as cheap, if not cheaper, than many of the ETFs out there right now. For example, the Schwab S&P500 Index Mutual Fund logs in at a miniscule 0.09% OER!

So, it’s not the wrapper that makes it expensive or not; it’s the methodology under the hood.

Do you use passive management, active management, or a combination? 

A combination. As a firm, it’s about 75% passive and 25% active. We generally use passive for our Traditional Core Equity and Fixed models, but use active for our Liquid Alternatives model. In most cases within today’s world, one cannot get alternative exposure without the use of an active manager. As the investment world evolves, it is possible that passive management will be employed more and more. But for now, we use what is available. (For more info on why we use both passive & active, see our March 2014 blog).

So why use alternatives at all?

The non-traditional alternative marketplace is an inefficient one. The use of active managers can help exploit these inefficiencies. Studies have shown that adding non-correlated assets, aka alternatives, to a portfolio can improve return and reduce volatility. Alternatives can help cushion your portfolio when there is stress in the traditional markets, thus creating a smoothing out effect on the long-term results of your portfolio. By incorporating a strategy where the majority of the portfolio is invested in traditional equities and fixed income complemented with a minority allocation to liquid alternatives, we can help protect the downside thus making new highs earlier and more often.

In a market environment that may produce only single digit returns, fees play a bigger role than ever. It is critical to use an investment manager like DWM who is looking under the hood and factoring in these costs when making investment decisions. Feel free to contact us for more info on how DWM keeps expenses to a minimum in its clients’ portfolios.

Plan For Financial Independence, Not Retirement

drseussWhen the Social Security program was started in 1935, the average life expectancy was 61 years old. Today, life expectancy is around 80, with more and more people living into their 90s and beyond. Yet, much of society continues to expect people to stop working in their early to mid 60s and retire, because giving up work is “simply what most people do.”

Yet, times are changing. People are working longer. And it’s not about economic distress. The WSJ recently reported that this trend is being driven by many highly educated workers in professional-services jobs who are sticking around by choice, doing something they love to do. Dr. Jan Abushakrah, 69, typically works 60 hour weeks as chairwoman of the gerontology department at Portland (OR) Community College. Retirement isn’t on her agenda. She says “As long as I am healthy and happy every morning when I wake up and have something exciting on my plate to look forward to, it is easy to say I could keep doing this forever.” Personally, I feel the same way. Helping people is a great way to spend your time.

Money isn’t the main factor that people keep working in later years. 67% do it because they want to stay active and involved. 51% enjoy working. 50% want to keep health insurance and other benefits. 47% need money to make ends meet. 38% want money to buy extras. 15% try a new career.

We have our clients target their “financial independence” date rather than their retirement date for planning. This is the date at which you have enough assets for the rest of your life without needing to work for money. The beauty is that once you reach this point, you keep working only if you want to. For those that have a vocation- a higher calling, rather than a job, and are making an impact, continuing to work is a likely possibility.

As someone approaches financial independence and can afford to stop working, they need to ask themselves a series of hard questions starting with “What would I do if I didn’t have to go to work today?” Certainly, there are physical activities, grandchildren, travel, education, charities and lots of other options. What combination produces a “series of successful days” that becomes a successful life? With financial independence, there are thousands of choices. You can make your own “cocktail” of choices every day.

Of course, it is important for spouses to work on these planning issues together. As financial independence approaches, both spouses should create an individual vision of what each wants to achieve in the next phase of life and then compare notes. Sometimes you have a situation where one person in the couple loves their job and the other only likes theirs. That’s a big difference. Communication, compromise and negotiation is key.

At the same time, older Americans are exercising more, which keeps them young. A recent study showed that how we age physically is, to a large degree, up to us. A recent study of recreational cyclists aged 55-79 by King’s College in London showed that on almost all measures, their physical functioning remained fairly stable across decades and was much closer to that of young adults than of people their own age. As a group, even the oldest cyclists had younger people’s levels of balance, reflexes, metabolic health and memory ability. However, the study showed that endurance and strength does decrease to some extent over time. All in all, though, aging is simply different for active people. On a personal note, for those of you who know I annually run the 10k Cooper River Bridge run here in Charleston, I am happy to report that due to some extra training and use of a coach, I was able to run my best time in 7 years last month. Not sure if I can turn back the hands of time, but maybe at least slow them down a little.

With Americans living longer, we suggest you focus on financial independence rather than retirement. At that point, you’re in control. You can determine what every day’s activities will be- hopefully, all things you want to do. You hold the keys to your future. As Dr. Seuss would say: “Oh, the Places You’ll Go.”

DWM 1Q15 Market Commentary

brett-blogBoring. That’s what we could call our investment style, but we like it that way. In baseball terms, which seems appropriate given Opening Day 2015 is upon us, we are all about cranking out consistent singles and doubles; we are not interested in striking out going for that home run. We use low cost securities that give us broad diversified exposure to many asset categories. This disciplined approach will take away the volatility found in speculative investors’ portfolios, provide more stable returns, and help one achieve their long term goals. It isn’t flashy, but it’s a tried and tested process that works.

As part of our philosophy, we believe:

  1. Traditional capital markets (like equities and fixed income) work and generally price securities fairly. (Which is why we use generally passive instruments in our equity and fixed income models.)
  2. Diversification is key. Comprehensive, global asset allocation can neutralize the risks specific to individual securities. (Which is why we don’t utilize individual stocks.)
  3. Risk & Return are related. The compensation for taking on increased levels of risk is the potential to earn greater returns.
  4. Portfolio Structure explains performance. The asset classes that comprise a portfolio and the risk levels of those asset classes are also responsible for most of the variability of portfolio returns.
  5. We can increase returns and minimize downside through portfolio design using our special blend of both passive (found generally within our equity and fixed income models) and active (found generally in our alternatives model) investment styles.

As one can see above, our approach involves the understanding of asset allocation – a portfolio’s mix of equities, fixed income, alternatives, and cash – and what mix is appropriate for the client based on their risk tolerance and other unique factors.

Given all above, to understand performance is to understand how the asset classes within your portfolio are doing. Hence, we find it prudent to incorporate a discussion on how each of the major asset categories (equities, fixed income, and alts) are doing within these market commentaries. The same way a baseball manager may look up and down his line-up, seeing what is working, what isn’t, and why? That being said, let’s take a closer look into how each asset class fared in the latest quarter:

Equities: The MSCI ACWI Investable Market Index, a benchmark capturing ~99% of the global equity markets, registered +2.3% for the quarter. International (+4.9%), small cap (+4.3%), and mid cap (+5.3%) outperformed large cap (+1.6%) this quarter. The S&P500/large cap has outperformed the other styles for a good while now, and as we have said many times before: expect reversion to the mean. Well, it’s happening. Traders and investors are noticing that the S&P500 is getting a little expensive, trading at 16.7 times forward 12 months forecasted earnings which is above the 10 year average of 14.1. The economies overseas may not be as strong as here in the US, but most are modestly improving and frankly international markets are cheap. Also there are many multinational companies that lie within the large cap space – with the dollar surging, the profits of these big boys are decreased.

Fixed Income: Most bond investments had modest price increases with the Barclays US Aggregate Bond Index up 1.6%. However, international markets didn’t fare as well as shown by the Barclays Global Aggregate Bond Index being down 1.9%. So what’s going on? Outside of the US, many central banks around the world are cranking up the easy money policies, bringing yields on overseas bonds down, in some cases to negative yields. US bond yields are very low but are higher than their international counterparts, so foreign buyers continue to buy our US bonds, thus pushing prices up. In fact, US Government bonds rose for the 5th straight quarter in a row as the yield on the US 10-yr Treasury Note fell from 2.17% at end of 2014 to 1.93%, confounding many traders that expected yields to rise in response to possible higher interest rates and improving signs in the US economy. We do think yields on the US government bonds should rise soon as the Fed has indicated an interest rate increase occurring in the near future. They’ve also made many traders happy when they said the cycle upward, once started, will be a slow one.

Alternatives: Nice start for the Credit Suisse Liquid Alternative Beta Index (+2.8%) and many of the liquid alternatives we follow. Of course, oil was down big, however if your current exposure to commodities was via a managed futures vehicle, you were most likely “short”. Which means that with commodities going down last quarter, you most likely profited. In fact, the AQR Managed Futures Fund which we follow was up 8.5% this quarter. Other notable alternatives include: 1) real estate, up +5.4%, as represented by the SPDR Dow Jones Global Real Estate Fund, and 2) a global tactical fund called John Hancock Global Absolute Return, which was up 3.7% on the quarter and invests by tactically trading (going long and short) equities, bonds, and currencies (e.g. betting the US dollar versus the Euro).

In our last quarterly commentary, we said to expect more volatility and indeed that’s what happened in 1Q15, as evidenced by the S&P500 closing up or down more than 1% nineteen times. But by continuing with our “boring” style, the expected increased volatility in equities won’t significantly affect our batting line-up. In fact, our ball club is built to endure whatever is thrown at it. By having diversified players (i.e. investment styles like equities, fixed income, and alternatives) focused on things that can be controlled, we’re confident this team can bring home the championship!

Brett M. Detterbeck, CFA, CFP®, AIF®