There are 100 exchange-traded funds with expense ratios of 10 basis points or less. The Vanguard 500 Index Fund charges 4 basis points, or 0.04%. Commissions on stock trades can be as low as $4.95, and even zero in some cases. We have reached a point where it is free, or virtually free, to invest — which is weird! Only recently, investing was expensive.
I began investing in the late 1990s, and after reading a couple of books on mutual funds I decided to go with no-load funds instead of those with sales charges. Why pay for something if you don’t have to? I would learn many years later that there are some very nuanced reasons why you might want to pay for something if you don’t have to.
Sales charges are a very subtle form of behavioral coaching: High fees discourage active trading, and most people are terrible active traders. The presence of a sizable front- or back-end load encourages people to stay invested so the returns keep compounding. There have been lots of studies that show how fees eat into returns over time. This is simple math. All else equal, if the expense ratio on your mutual fund is 1%, you will have less money at some point in the future than if you had put your money in a fund with an expense ratio of 0.1%.
I keep waiting for opinion pieces touting how investment expenses have sunk to negligible levels, but people still seem to complain about such fees. What are they unhappy about? By and large, they are unhappy with their own performance amid one of the longest bull markets ever. Those who bought in 2009 and held on until today would be pretty happy, but I get the impression that very few people did that. They either bought too late, sold too early, panicked and puked at the worst possible time, or chased a hot new trend.
The result is that they inevitably underperformed a 60/40 mix of stocks and bonds , which would have provided about a 10.4% return since the start of 2009. Heck, it would have provided 6.34% since the beginning of 2007 — the top of the last bull market.
But people are rarely satisfied with what they have. It has long been my position that investors’ worst enemy isn’t fees but their own suboptimal behavior, which never gets better. Even Vanguard knows that the returns advertised on its funds are not the returns achieved by its investors because low fees result in higher turnover, which results in lower returns — usually.
I have known my share of rich people, and the people I have known who have gotten rich, or at least semi-rich, passively through investments did not do so by chasing low fees. Most were customers of full-service brokerages and their high commissions of — gasp! — six to 10 cents per share. They bought stocks and mutual funds and held onto them forever because, in part, the cost of selling was high. And if there was a downturn in the market, they had a live person on the other end of the phone telling them that this too shall pass and to stay invested. In a not-very-diversified portfolio of 20 or 30 stocks, there is a good chance that one or two of those trees will grow to the sky in 20 years.
The ideal model would be one where people invested in low-cost index funds had behavioral coaching to keep them invested during the downturns. But nothing costs nothing! In the past, a broker’s compensation included payment for distribution of certain mutual funds. Take those payments away and it’s hard to make the economics work as a financial adviser. Index funds are primarily a do-it-yourself phenomenon, and it’s hard to justify paying an adviser 100 basis points just to pick funds when robots will do it for much less.
On the other hand, fees are but one factor to consider when picking funds. Returns are another obvious factor, but there’s also volatility, correlation with other assets and the particular risk characteristics of a particular fund. You can’t look at fees in a vacuum. Also, investors make bad decisions, but there is a lot of work that goes on at the fund level to make sure that doesn’t happen, which is what you theoretically pay with active management.
It is good for the consumer that fees have dropped. It’s capitalism at work. The cost of most things will drop over time in a competitive market, and asset management is very competitive. My sense is that we have become too obsessed with fees at the expense of thinking about things like portfolio construction. Let’s declare victory on fees and try to help investors think about how to build an all-weather portfolio that can compound for many years to come.