Cost effective portfolio implementation should be a critical component of every advisor’s toolkit. This is based on the simple truth:
Gross investment returns – Costs = Net investment returns.
Costs include expense ratios, trading or frictional costs and taxes. Every dollar paid for fund management, trading costs and taxes is a dollar less of potential return.
The Value of Low-Cost Funds
Vanguard’s Advisor’s Alpha® study finds that investors can save up to 40 bps (0.40%) annually by moving to low-cost funds. This value-add is the difference between the average investor experience and funds that would be considered low-cost. It goes without saying that if an investor’s fund expenses are higher than average, their savings would be even more. Vanguard’s study only takes explicit carrying costs, such as fund expense ratios, into account and is extremely conservative considering fund investment costs will often include sales commissions and 12b-1 fees. Our experience here at Claris leads us to believe that the annual savings for the average investor is likely higher than 40 bps.
If low costs are associated with better investment performance, which research has repeatedly shown to be true, clients should demand that fund expenses play a leading role in an advisor’s investment selection process. Critically, this value-add identified by Vanguard has nothing to do with market performance. When an investor pays less in fund expenses they keep more of the returns, or losses are smaller, regardless of whether markets are up or down. In fact, in a low-return environment, costs are even more important because the lower the returns the higher the proportion of those returns that is consumed by fund expenses.
Look out for the next installment in our Value of an Advisor Series: Portfolio Rebalancing. If you have any questions about implementing a cost effective portfolio, contact Claris.
Read Part 1: 7 Strategies to Quantifying Value
Read Part 2: Asset Location
Read Part 3: Asset Allocation
