You Are Paying Too Much! (Part 1 of 3)

If I were to ask you how much you were paying for those funds in your brokerage, or retirement, account would you know? My guess is that you would have no idea, and that is not your fault. After all, you don’t know what you don’t know, so how would you even begin to know where to look. Let me guide you…

This is a three part series focused on some very basic, yet not very transparent, expense/income and performance related metrics for mutual funds and exchange traded funds (ETFs). Jot these terms down: Net Expense Ratio, 12b-1, dividend yield and, the bain of your taxable investment portfolio’s existence, capital gains exposure. Part 1 focuses on Net Expense Ratio. Part 2 focuses on the 12b-1 fee and dividend yield. Part 3 focuses primarily capital gains exposure and guidance on how you can research these important metrics to ensure you have the most suitable investments for your portfolio.

Let’s kick this off with Net Expense Ratio (NER). The NER is expressed as a percentage of the fund assets used to pay for the operating expenses, management fees and all other asset-based costs incurred by the fund. The NER is baked into the price you pay for the fund when you buy it, so unless you know what to look for you don’t actually know how “expensive” your fund might be relative to other alternatives. Let’s compare two investments for illustrative purposes: the BlackRock Equity Dividend Fund (MCDVX, C-shares) and the Vanguard Value ETF (VTV). Both investments are widely used and actively traded on the market. I will be using Morningstar for all of the data used in these comparisons (click here to access Morningstar).

Both MCDVX and VTV are comparable large-cap value investments, comprised of similar companies with varying weights within each fund. MCDVX is an actively managed fund, meaning that someone in a corner office with a team of people is actively buying and selling holdings within this fund in an attempt to generate better-than-market returns. VTV is a passive investment, meaning that a computer algorithm rebalances the holdings (generally quarterly) based upon the market cap of the companies contained in the fund.

The BlackRock fund carries a Net Expense Ratio of 1.70% based upon their 11/28/2016 prospectus. The Vanguard Value ETF carries a Net Expense Ratio of 0.06% based upon their 04/27/2017 prospectus. Very simply, if you own $50,000 of MCDVX then you are paying BlackRock 1.70% x $50,000, or $850, per year for their management of your investment. If you own $50,000 of VTV then you are paying Vanguard 0.06% x %50,000, or $30, per year for their management of your investment. Over a three year period you would be paying $2,460 MORE for the BlackRock fund. That’s a pretty big difference for similar investments.

I know what you are thinking, the expense ratio is important, but it doesn’t tell the whole story. That is a correct statement; however, the NER is a great starting point for your analysis because the difference in NERs between holdings is the ground the more expensive fund must make up for in terms of performance and/or dividend yield. Remember, total return is the sum of underlying growth PLUS dividend yield. So, in the above example, the BlackRock fund must outperform the Vanguard fund by $2,460 in total return, or 500 basis points (5 full percentage points!) on that $50,000 investment over that three year period just to break even!!! That is a LOT of ground to make up.

I hope you now have a better understanding on the cost associated with owning various types of fund investments. The Net Expense Ratio is one of many critical parameters that require assessment when selecting the most suitable investments for your portfolio. Stay tuned for Part 2 coming later this week!

As always, Phoenix Financial Engineering is here to held guide you through the investment selection process so that your investments are the most suitable for your goals and objectives. Give us a call!