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Stingy Investor Tip Sheet
I had the pleasure of talking to the Ryerson Investment Club today.
You can flip through my overhead slides via the following link.
Practical Portfolio Construction
The first part of my talk focused on fees, taxes, and other things
that tend to lower investment returns. I presented very similar arguments
Partners. But in today's talk I went a step further. Slide 9 shows the
downside of high fees, high taxes, inflation, and bad timing.
I briefly quote several bad timing studies on slide 8. The
numbers change from study to study, and they depend on the time period
in question, but poor timing drags down returns by roughly 3
percentage points a year for many fund investors. Unfortunately, that
includes index fund investors.
For instance, morningstar.com currently reports that the Vanguard Total
Stock Market Index Fund (which sports a low annual fee of 0.15%)
provided annual returns of -2.67% over the last 10 years through to
the end of February 2009. But investors in the fund earned -7.91% a
year over the same period. That is, investors trailed the fund's
quoted performance by 5.24 percentage points a year. That's a
stupendously high level of underperformance.
Essentially, investors trailed the index fund by buying high and
selling low. They piled in on the way up and invested more money
near the top. On the other hand, the fund's raw (or time-weighted)
performance figures assume that the entire investment was made at the
start of the period under observation.
The timing problem is huge but I'm not sure there are any easy
solutions. After all, prices become dear when everyone wants to buy
and then they collapse when everyone wants to sell. It's a feature of
the markets. Of course, a few investors can avoid timing drag but not
all of them.
On Performance Fees
I also encountered a nice investor who pays their broker a performance
based fee. The arrangement was quite rich. They pay nothing if
annual returns fall below 5% but they pay 50% of any gains above 5%.
To put this into context, let's look at applying a similar fee
arrangement to the returns on the S&P/TSX Composite index. The
S&P/TSX Composite provided average annual returns of 10.5% from 1970
to 2008 and grew a $1,000 initial investment into $29,780. But if you apply a
fee of 50% of gains over 5%, then your after-fee return would be 5.5%
annually and a $1,000 investment would only grow to $5,880.
The fee arrangement is a great deal for the advisor but it doesn't look
like a good one for the investor. It also appears to conform to the
cynical old saying that the stock market is a place where people with
experience get the money and people with money get the experience.
|03/11/2009 8:30 PM EST Permlink save & share||Markets|