The 2%/50% rule: How fees and under-diversification can cost half a pension

In my previous post, I mentioned that one of the top 10 lessons I learned in my first 10 years of investing my salary savings, bonuses, and 401(k) contributions is to beware of high-fee, low-service mutual funds and financial products.  As a professional myself, I of course understand the need for professionals who manage and distribute mutual funds to get paid, but I also firmly believe it is wasteful to pay more for something that doesn’t actually provide any additional benefit.  It may make perfect sense to pay 1.2% per year to an investment manager that actually provides personalized service, financial planning, and helps construct a portfolio that better suits you, just as I believe it makes sense to pay more for a nicer suit that actually fits me from a tailor who provides me good service.  On the other hand, I believe it is wasteful to pay 1.2% for a domestic stock fund that provides no better access to the ups and downs of broad market stock returns than an index fund with a 0.2% fee, or worse, uses the extra 1% fee to pay managers to over-trade the fund and cause the fund to underperform the benchmark by another 1% (as more than half of actively managed funds do).  I believe in a limited amount of active management, especially in less efficient markets, but believe it is even more important to use active management to tailor portfolios to client needs and to ensure a high return on the effort in actively managing investments.

A 2% difference per year may not seem like much, until you consider this: $100,000 invested at 7% for 35 years grows to $1,000,000, while the same $100,000 invested at 9% for the same 35 years grows to $2,000,000.  This #MillionDollarDifference goes partly to fund fees themselves, but even more from those fees not resulting in higher returns of even 2% per year.

American Funds, Franklin, PIMCO, and First Eagle, and MFS are just among a few of the names of fund providers who have US mutual funds with over $40 billion under management and expense ratios over 1.1% per year. Here in Hong Kong, HSBC and other firms also run high-fee funds where I have yet to see any service or performance advantage over holding an index ETF or passive stock portfolio.

So simply put: know what you pay for financial services, and what you get for the fees you pay.

Until next time,

Tariq

+852 3468 5490

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