[pullquote-right] “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.” [/pullquote-right]
Investment costs are a primary, yet commonly and greatly underestimated, driver of portfolio performance. Investment costs compound—except in an undesirable way! Costs are negative returns, and they compound (negatively) over time. The more an investor pays to implement his portfolio, the exponentially less he will net over time.
| Fee | Description | Very High | High | Moderate | Low | Very Low |
| Management Fee | investment management | 1.50% | 1.20% | 0.80% | 0.30% | 0.10% |
| Transaction/ Trading Costs | bid-ask spread, market impact, commissions | 1.20% | 1.00% | 0.60% | 0.30% | 0.10% |
| Taxes | income (dividends); capital gains; tax loss harvesting | |||||
| Inflation | government CPI; “actual” core inflation | 8% | 6% | 4% | 2% | 1% |
| Financial Advisory | financial advisor: asset-based or fee-based | 1.50% | 1.25% | 1.00% | 0.50% | 0.25% |
| Sales and Distribution Fees | 12-b1 fees, sales loads | 10% one-time | 7% one-time | 5% one-time | 1% annually | .25% annually |
How We Manage Each Type of Costs
- Management fees: we favor low-cost products such as index funds/ ETFs. For active funds, we favor managers who charge less, typically under 1%. We avoid pricey private, hedge, or alternative funds.
- Savings estimate: 0.50% – 1.00%
- Transactions/ trading costs: we conduct our trading transactions through discount brokerage firms with excellent market access to minimize spread and impact costs. We favor funds with low turnover, especially in illiquid asset classes.
- Savings estimate: ???
- Taxes: we are mindful of tax-efficiency and asset location (e.g. bonds). We favor tax-efficient products such as index funds. We strive to avoid short-term capital gain realizations when possible, and opportunistically harvest tax losses.
- Savings estimate: 0.50% – 1.50%
- Inflation: since we live off real returns (not nominal returns), we include some inflation-protected assets, such as real estate and commodities. We also keep a very modest, if any, amount of cash.
- Financial Advisory: self education, financial literacy, and financial DIY
- Savings estimate: 0.50% – 1%
- Sales and distribution fees: we disqualify products with high access costs, such as sales loads. We tend to avoid even (modest) distribution (e.g. 12b-1) fees.
- Savings (estimate): 0.25% – 2% annually
- Impatience/ poor timing: we follow a disciplined investment process to avoid market-timing and emotional reactionary trading. We avoid chasing hot asset classes and always wary of bubbles. Large investor flows and new product launches are often a contrarian indicator. We favor consistent investment strategies that avoid large drawdowns.
- Savings estimate: 1% – 5%