Scott Burns: Weigh the costs and odds

Mar. 1, 2014

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Scott Burns

Scott Burns

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I am an active Army officer.  All my investment accounts are with a single asset management firm.  The mutual funds in my Roth IRA have expense ratios of 1 percent or higher.  But when you look at their Morningstar returns, the portfolio of loaded, actively managed funds outperforms my Vanguard account, with less market risk. 

I also pay a wrap fee of 1.15 percent.  It is only $500 a year for my $50,000 account, but over the next 40 years, that will be $20,000.  That makes me wonder what the lost gains on that $20,000 might be. 

Is the fee worth the potentially higher returns of the managed account? —  R.A., Amarillo, Texas

We all have a time perspective problem when it comes to investing.  Since the value of stocks and bonds can shift by 1 or 2 percentage points in a single day, it doesn’t seem unreasonable to pay 1.15 percent a year to manage a portfolio of mutual funds.  In fact, the longer you invest, the more danger such fees pose to your long-term return. 

You are spending 1.15 percent, certain, in the hope of higher performance, uncertain, through astute management.  But in this example, the cost of management, all by itself, will take your performance down by 35 percentile.  What are the odds the managers will overcome the burden of their own expense over the long term? 

These figures, by the way, don’t include another burden.  Your asset managers have chosen to put your money into managed funds with fees of at least 1 percent.  Yet multiple research studies have shown that 70 percent of all managed funds can’t beat their appointed index.  As a consequence, your portfolio manager is building your portfolio with funds that, by themselves, have only a 30 percent chance of sustained superior performance — and that’s before the percentile-dropping cost of the wrap fee. 

This isn’t about this particular firm.  Lots of other organizations have the temerity to charge still more.  The problem here is fundamental.  Money management is a low value-added business.  It should charge accordingly.