Portfolio Returns Being Eaten by Expenses? Try These Two Techniques
Diversification and asset allocation are just two of the many key concepts of investment management, but there are other things that an investor must watch out for in order to attain a decent rate of return.
According to Demos, an online think tank, over a lifetime, a family with two income earners will pay almost $155,000 in fees to service their 401(k)s and will decrease their returns by one-third. ( Source: Hiltonsmith, R., “The Retirement Savings Drain: Hidden & Excessive Costs of 401(K)s,” Demos web site, May 29, 2012, last accessed January 30, 2013.)
Investing expenses associated with investment management can sometimes take positive returns into negative territory. On the hand, if they are managed properly, investors can earn phenomenal returns over time.
In simple terms, the less you pay in expenses, the more you get to keep.
Consider this scenario; say you purchase 100 shares of ABC Inc. at $20.00 per share. A few months later, you find that the stock price has risen to a level where you think it doesn’t have much room to grow—say, $25.00 per share. Without any expenses, on this trade, your return would be 25%.
Now, let’s say you paid $10.00 per trade—$20.00 to buy and sell the 100 shares of ABC Inc. Your return in this situation is actually 24%; paying a fee for the trade decreased your return.
Here are two ways you can save money while employing proper investment management techniques:
1. Exchange-Traded Funds (ETFs) Versus Mutual Funds
Mutual funds were created to provide investors with diversification and professional money management. In exchange, investors were charged management expenses and other fees—which can sometimes exceed five percent of the amount invested.
Now, thanks to financial innovation, investors can save a huge amount of money through ETFs.
Expenses for ETFs aren’t high compared to those of mutual funds, and ETFs are marketable during the market’s regular hours. For example, the SPDR S&P 500 ETF (NYSEArca/SPY), which tracks the performance of the S&P 500, has an expense ratio of just 0.09%—much lower than the average fees charged for mutual funds.
2. Passive Investing Versus Active Trading
The question of passive investing versus active trading has been an ongoing debate in the world of investment management for a long time. Active investing simply means that an investor makes trades on a fairly short-term basis. While this strategy may suit some people, it’s certainly not for everyone. When a person is actively investing, their trading cost will be much higher than that of the investors who wait and make fewer trades.
If you are planning for retirement, then active trading might not be a good idea. Not only does it add to your trading expenses, but it also increases your stress level. Passive investing isn’t completely worry-free, but it is much less stressful.
Along with investment management techniques, if an investor manages their investing expenses wisely, their portfolio returns can be significantly higher. As they say, a penny saved is a penny earned. If you can control your trading expenses, your savings will add up and reward you in the long run.