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Cheap isn't better. Why expense isn't such a big deal.

Cheap isn't better. Why expense isn't such a big deal.

| October 05, 2015
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Investing

"Price is what you pay. Value is what you get." - Warren Buffett

Let’s take a moment to talk about investment expenses. Whether it’s within a mutual fund, separate account, ETF, UIT, CEF or other investment vehicle, expenses matter! But they aren’t the only consideration. Have you heard the adage that cost is only an issue in absence of value? This can be painfully true in the investment world for both good and bad.

Take this example:

  • Fund A and Fund B are identical except for expenses.
  • Fund A costs 0.20% per year and Fund B costs 1.2% per year. (1% extra expenses)
  • During 10 years, Fund A grows by 8%. Since Fund B is 1% more expensive, it only grows by 7%. Starting with $100k, Fund A would make over $20,000 more in 10 years.

This is the indexer argument. Expenses are such a big drag on investments that cheap is "best." That would be great if the theory held true in practice. Unfortunately outside of competing index funds, this isn’t the case.

Let me put it this way, the above theory is like saying everyone should drive a Toyota Yaris or Ford Fiesta. They are cheap, efficient, no surprises other than tiny trunks. This theory says there should be no Lexus, Mercedes, or Tesla… When all that matters is getting from point A to point B and that comfort, design, speed, technology and all the rest don’t count, then yes, jump in that Ford Fiesta. If all that crazy noise is important to you, it might be a good idea to look into something a little more refined.

In my investment research for my client portfolios, I run a fiduciary screen that has nearly 100 potential screening options such as average returns, measurements of risk, risk adjusted return, manager tenure, fund expenses, consistency and more. Expense comes into play, but for an overall financial benefit to my clients, I seem to find much more value looking into the other parameters than I do looking at fund cost. I’d rather see my clients with an abundance of value and I can’t get that by only shopping on price.

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