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The Biggest Four Letter Word In Investing

Charley Ellis of the Rebalance IRA Investment Committee talks about investing and how to avoid paying too much in fees.

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Transcript:
Fees are really important. And people looking at fees say, “No, they can’t be.” And I say, “Yes, they are.” And people say, “They can’t be.” And then they think of a four-letter word and a single number. The single number is 1%. The four-letter word is “only” — only 1%. And that is not an accurate way of describing fees.

First, you ought to say, first of all, you’ve got the money. So you already have your money. So it’s not 1% of your money. It’s 1% of something else. Your manager, okay, he’s going to deliver investment results. Fine, what investment results is a normal expectation, 7%, 8% maybe? Okay, let’s say 7%. What is the fee of 1% of assets, what’s that same amount as a percent of returns? About 15%. Fifteen percent is a lot different from 1%. You don’t use the word “only” with 15%.

Then you say, “Wait a minute. I remember in economics. In economics, we said everything was price comparative.” So, I know there’s a commodity product called an index fund. And it’ll give me the full market return at no more than the market level of risk, absolutely assured, reliable, over and over and over again.

So if go to active investing, I’d better get either a lower risk or a higher return. And what’s the fee as a fraction of that higher return or lower risk? And there, unfortunately, the fee works out to be — incremental fee for active over the fee for indexing — turns out to be over 100%.

There is no better way to identify which funds will have the best future returns than low cost. And low fees is, over and over and over again, the best predictor of better results. Even the head of Morningstar has explained it. They’ve done the research and come up with the best predictor of future performance is low fees.

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