This is the third of several guest posts by Nathan Bush on 12 investing concepts.
CONCEPT SIX—FEES
It does cost money to buy, sell, and hold securities. If you need advice, that cost also (one-time fee or ongoing percentage of assets under management). The construction of indexes and funds cost money. There are sales commissions. It is your money but everybody wants some of it, and do deserve some of it. Nothing is free. Historically, most everybody overcharged given what they did, but the trend is moving toward much more efficient (cheaper) marketplace.
Vanguard, which is a Mutual company (fund holders own the company) deserve much of the credit for driving down the cost between its competitors. Fidelity, Schwab and all the others have to make a profit and pay dividends to their stockholders. In addition, recent technological advances and computer trading have increased the efficiency of the market. Cost is the differentiation factor between different funds. Cheaper is better. You get what you don’t pay for.
The Expense Ratio (E/R) is the common measure of the cost of the fund. Schwab just reduced the E/R for its broad market equity index fund (SCHB) to 0.03% for online accounts. This is certainly a loss leader driven by competition, but Schwab still makes its money with the other services it provides to traders, stock pickers, and active funds users.
A typical investor with an advisor who charges a fee plus sells high cost active funds could very easily be paying 1.5% to 2.5% of the value of his portfolio each year while the “Do It Yourself” indexer would be paying less than one half of one percent. The difference seems small, but the compounding could add up to thousands or hundreds of thousands of dollars over time.
Look at the Hypo-Folio:
ETF $ Value E/R Cost
SCHB 357,000 0.03 107
VBR 63,000 0.09 57
SCHF 133,000 0.08 106
SCHE 56,000 0.14 78
VSS 56,000 0.19 106
SCHZ 132,000 0.05 66
SCHP 30,000 0.07 21
Stocks: GE 35,000 * 16 (one time trade 7.95 each)
I-Bonds 96,000 ** 0 (Government direct no fee)
Cash 42,000 *** 0 (bank pays me negligible amount)
Total $ 1,000,000 $ 557
On this million-dollar portfolio, the cost is $557 while the “Typical investor” would be paying 1.5 % (or more) or $15,000 per year, every year. COST MATTERS!
CONCEPT SEVEN—EQUITIES
Equities or stocks are a part ownership of a company and as an owner, you are entitled to part of the profits and dividends and the stock price appreciation over time. There are no guarantees. The value of the company may go down even to zero (think Enron). Since equities carry this risk, you can expect to be paid a premium for taking this risk. Stocks make more than bonds (which are less risky). Stocks are categorized by Size and by Sector of the market. Funds are categorized by Style (Growth or Value or Blend of both)(As well as Size).
SIZE
Large Cap—over $10 Billion Market Cap
Mid Cap—between $2B and $10B
Small Cap—between $300 Million and $2B
Micro Cap—under $300M
SECTOR
Communications—Verizon, AT&T
Consumer Discretionary –McDonalds, Ford, Disney
Consumer staples—Coca-Cola, Kellogg, Walmart
Energy—ExxonMobil, Halliburton, Baker Hughes
Financial Services—American Express, Berkshire, J P Morgan Chase
Health Care—Johnson& Johnson, Merck, Lilly, Pfizer
Industrials—3M, Boeing, John Deer, FedEx, GE
Materials—Dow Chemical, DuPont, Monsanto
Technology—Amazon, Apple, Microsoft, IBM
Utilities—Duke Energy, Southern Companies, PG&E
STYLE
In the Hypo-Folio, SCHB is a broad market (large, mid& small caps) (growth and value or Blend) (covering all sectors). VBR is a Small Cap (with a few mid-caps) Value.
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