One of the foundational underpinnings of our investment approach at XSpot Wealth is the simple premise that “costs matter.” We are diligent in our analysis of costs relative to the value received by our clients that’s why our approach to long term wealth maximization uses ETFs rather that Mutual Funds. Mutual funds carry many costs, all of which affect net return to investors.
Why we choose to invest in ETFs?
Diversification: By investing in ETFs, client’s investment will spread across hundreds or thousands of different companies. These companies will be in different industries (technology, healthcare, mining, etc.) and will also be in many different countries.
Simplicity: If a client wanted to replicate the diversification of an ETF on his own, he’d need to manually make investments in thousands of companies. This would require a mind-boggling amount of work.
Low fees: When a client invests in an ETF, he’ll pay an annual “management fee”. This is paid to the company that creates and manages the ETF to compensate them for executing the trades, re-balancing the allocation, admin and paperwork. ETFs have extremely low fees.
In addition, research has shown that over long periods of time (10+ years), more than 90% of actively managed mutual funds have lower investment returns compared to a low-cost passive investment strategy. How is this possible? How can Ivy-league educated fund managers do worse than an average investor using a simple passive investment? The answer lies in the extremely expensive fees that these managers charge. Before fees are taken into account, these managers tend to have performance which matches the overall market. However, after their fees are taken out, the returns for actively managed mutual funds significantly lag behind the overall market. These fees are what the manager pockets, and the return after fees is what client keeps. By minimizing fees, client ends up with higher returns. A high expense ratio also presents a challenging hurdle for many mutual funds, especially over longer time horizons.
The impact of minimizing management fees can be massive when this occurs over a long period of time.
Let’s take a look at some real examples.
Take the example of a 35 year old who saves 5,000 per year for 40 years. By using a low-cost, diversified, and passive investing strategy with annual rebalancing and earning a real return of 7% per year, he’ll end up with 472k by age 65. If instead he invests his money in an actively-managed mutual fund and only earns 5% per year after fees, he’d have 332k. 140k euros has been eaten up by fees.
The picture below is showing the Vanguard VOO ETF. This ETF tracks the S&P 500 index. The “expense ratio” is only 0.03% per year ($3 per year on an investment of $10,000).
Now compare this against an actively managed Fund of Funds of a major Greek bank. Only, the ongoing charges for this fund are over 2.5% per year — more than 8 times higher than the S&P 500 ETF.
An other issue with active management approaches, such as stock picking or market timing, is that both the total amount of trading and the cost per trade may be high. If a manager trades excessively or inefficiently, costs such as commissions and price impact (bid/ask spreads) can eat away at returns.
In contrast to active strategies, keeping turnover low, remaining flexible, and transacting only when the potential benefits of a trade outweigh the costs can help keep overall trading costs down and thus reduce the total cost of ownership.
Reducing costs and, more importantly, receiving value for cost are some of the primary reasons that we work closely with major ETF issuers for the implementation of our portfolios on behalf of clients.
For individual investors, the total cost of ownership of a mutual fund requires a thorough understanding of costs beyond what an expense ratio may tell on its own and therefore can be difficult to assess. For XSpot Wealth clients, we make sure to look beyond any one cost metric, and instead evaluate the total cost of ownership of an investment solution relative to the expected value that will be received. This is our fiduciary obligation and commitment to them as we manage their portfolio and partner with them to achieve their financial goals.
This document does not constitute and shall not be construed as a prospectus, advertisement, public offering, or placement of, nor a recommendation to buy, sell, hold or solicit, any investment, security, other financial instrument or other product or service. This document is for general information only and is not intended as investment advice or any other specific recommendation as to any particular course of action or inaction.