Is the glass half empty or half full for everyday investors?
Younger savers such as myself — and please, do not refer to us as “Millennials” — can be forgiven for having mixed feelings about Mr. Market. Many of us had just begun putting savings into 401(k) or IRA plans, when the crash of ’08 taught us the meaning of the words “risk tolerance.”
As a generation, we’ve wised up since then (a bit). My own know-it-all attitude, along with my 100 percent equities allocation, is long gone. At least, the ridiculous allocation is. So that’s progress.
Moreover, the intervening years have been uncommonly kind to retail investors. Our sage Central Planners have helpfully pumped up asset prices beyond all reasonableness, which has given nearly everyone, along with their cousin Steve, amazing “paper returns” over the past half-decade. Meanwhile, the investing industry has “gone Costco” with ever-cheaper ways to own any asset class under the sun. “Would you like an ETF with that? That’ll be 15 basis points, please.”
We mutual fund investors have reason to celebrate too: the ETF boom as helpfully injected even more competition to an already competitive asset management market. As a converted Boglehead, I’ve configured my family’s main portfolio to be resolutely boring, and frugal. Boring because it’s three-fund, and 60/40. (Are you asleep yet?) But also frugal, because its three mutual funds (VTSAX, VFWAX, and VWIUX) have an average weighted expense ratio of right around 11 basis points. Meanwhile, I’m not paying for advisory services, trading fees, or anything else. Pretty sweet deal, right?
The frugality is not so much “sweet,” I’m afraid, as it is utterly critical. I’m no fan of market forecasting, but I believe it is helpful to periodically put valuations in their long-run historical context (if, for no other reason, than to annoy your cousin Steve at holiday gatherings).
If you scan Rick Ferri’s 2015 30-year market forecast — and a scan is all that’s necessary (remember, this is a forecast) — you’ll see a lot of fours and fives, with a few sevens and eights thrown in. Double digits? Forget it. The sophic Central Planners have seen fit to fast forward much of our potential future returns, via the Quantitative Easing policy.
Note: If you’re unfamiliar with the inner machinations of QE, as it’s known, let me suggest my own conclusion: QE is a political policy that covertly transfers wealth via rising asset prices mainly to the old, to the rich, and to nearly-insolvent financial institutions. Whence does the wealth transfer originate? From thy own pocket, Millennial!
Curmudgeonry aside, there’s no use complaining. Mr. Market (with an “assist” from the perspicacious Central Planners) has dealt you a hand, and you will play this hand, whether you will it or no. Which brings me back to valuations, and fees.
Taking my 60/40 three-fund portfolio as an example, we’ll be optimistic and forecast an overall annual return of 600 basis points over the next decade or two. Now, pretend you’re working with a 1980s-era investment planner. 100 basis point annual advisory fee? Check. Add in some 500 basis point mutual fund “loads” (with an average holding period of five years), and that’s another 100 basis points of annual holding cost. The funds themselves, of course, charge an additional annual fee of 100 basis points. And, let’s be optimistic, and assume that inflation will stay tame, and average only 200 basis points per year.
Did you type all this into your PDA calculator? The net annual real return to you (assuming you’re working with this ’80s-era investment planner) is a measly 1 percent. Actually, that assumes we’re talking about a tax-deferred account. If this is in a taxable investment account, Uncle Sam will easily grab that last hundred basis points (and more) that was left sitting on the table.
Congrats ma’am, you’ve just been elected the Mayor of Negative -Returnsville!
The good news is, our current sky-high valuations, and their commensurate measly yields, need not be accompanied by a 1980s-era fee structure. Enterprising investors can effortlessly design any reasonable portfolio, for a gross cost of 10 or 20 basis points per year (or 50, if you have very exotic tastes). In which case, future gross annual returns of, say, 5 percent — subtracting only inflation and these rock-bottom fees — will still be materially positive in real terms (although that second home may not be in your future).
So: should you be happy, or depressed, about the current retail investment landscape?
Maybe it’s fatherhood, or the fresh country air I’ve been breathing, but I choose to be content. A forecast of depressed future returns is just that: a forecast. Two hundred-plus basis points in annual fee savings is guaranteed cash in your pocket. Losing paper gains to Mr. Market feels bad, but paying back your entire annual portfolio yield to the financial services industry feels even worse.
If you “go Boglehead,” you can pay their fees in dimes and quarters. It was the worst of times — it was the best of times.
September 11, 2015: This article has been updated with relevant links to the Fund Reference database of mutual funds.
About the Author: Andy Hagans
Andy Hagans is editor in chief for Fund Reference, and also serves as CEO of parent company Poseidon Financial. He is passionate about the “Bogleheads” school of investing, and is focused on helping investors achieve higher net returns via tax efficiency and fee minimization. He resides in southwest Michigan.