We are usually quite proud of ourselves when we manage to save money on our purchases, whether by buying something on sale or using a coupon. Why is it that we don’t apply this mentality to our investment portfolios?
Credit Card Deadbeats
I recall watching a "Frontline" documentary on PBS in 2004 called “Secret History of the Credit Card." Ben Stein, economist and actor, prided himself on the fact that he paid off his credit cards monthly but reaped all the rewards of air miles or cash back on his purchases. It was revealed that the credit card industry referred to customers that did this as deadbeats.
I pay off my credit cards monthly and seek to use those cards that provide me the best rewards. I am proud to be a credit card deadbeat. In fact, I’m always looking for prudent ways to be a deadbeat when it comes to maintaining my wealth. (For related reading, see: Why Making Minimum Payments Gets You Nowhere.)
It dawned on me that a lot of money disappears in the form of fees and expenses within our investment portfolios. According to Lipper, the average mutual fund charges an internal expense ratio around 1% annually and according to Pricemetrix the average advisor charges 1% annually. Put them together and you could be losing 2% or more of your portfolio’s value to fees and expenses every year.
How to Reduce Investment Fees
This no longer needs to be the case. There are now many ways to proactively minimize fees and expenses associated with our investment portfolios. Many exchange traded funds (ETFs) and indexed mutual funds represent the important asset and sub-asset class components of a well-diversified portfolio and charge under 0.25% for their annual expense ratio.
Building a simple portfolio is relatively easy once you have determined an appropriate asset allocation of stocks, bonds and cash. Indeed, many diversified managed accounts benchmark their performance against such a simple indexed structure of four or five components and fail to beat that benchmark on a consistent basis. (For related reading, see: Pay Attention to Your Fund's Expense Ratio.)
How to Determine Asset Allocation
To determine an asset allocation for your portfolio, you might visit the internet and search for an investment profile questionnaire. There are many free questionnaires on the internet that can be utilized to determine an appropriate asset allocation. Once you are pointed to an asset allocation, be sure to review its historical performance and be comfortable with the risk and volatility associated with it.
Most asset allocation recommendations will be a simple mix of domestic stocks, foreign stocks, bonds and cash. These components can be easily represented with ETFs or indexed mutual funds in building your portfolio.
All in all, most investors should be proactively trying to keep their fees and expenses below 0.5% when trying to minimize the costs associated with their nest eggs. Even if you are simply aware of what you are currently paying for your portfolio and have a desire to minimize those expenses, you will be on your way to becoming a “Wall Street deadbeat." (For related reading, see: Achieving Optimal Asset Allocation.)