We’re all aware of the need to minimize investment costs as much as possible. The lower the investment costs, the more you actually earn.
All companies who manage mutual funds and Exchange Traded Funds (ETFs) charge fees to cover investment expenses.
Those costs are largely unavoidable. It costs money to buy and sell stocks and bonds; print and mail shareholder communications; hire attorneys to obtain regulatory approvals and comply with government rules; accountants to prepare annual reports and tax advices; portfolio managers to select investments and conduct research; and marketers to get the funds available and on your broker’s “supermarket shelves.”
One way we can lower your overall investment expenses is by selecting more low-cost investments like index funds or passively-managed Exchange Traded Funds (ETFs).
What exactly is a passive investment and why is it cheaper?
“Active managers pick stocks and bonds that they think will let them outperform the overall market. Passive managers don’t try to outperform. They buy a market basket of investments so they can reduce costs and obtain average market returns,” explains the Wall Street Journal. By tracking an index and buying a market basket of investments, passive funds and ETFs can dispense with the services of a high-priced portfolio manager and save money on trading costs.
How cheap are these newer ETFs? Very cheap.
Intense competition among investment companies like Charles Schwab, BlackRock and Vanguard benefit you by driving investment costs downward. In fact, some product fees are getting close to hitting zero.
Recent price cuts announced last week make Schwab the lowest cost investment provider in many asset categories, with some funds priced as low as 0.03% (0.0003) of assets per year.
That can translate into huge savings for you and your portfolio.
One caveat. Just because ETFs are cheap, doesn’t mean they are always the best choice for your portfolio. We compare investments on an “after-fee” basis, looking at what they earn for you after fees have been paid. In some cases active funds can be preferable, even if fees are higher, because they can reduce risk, weed out lower quality companies, generate higher income, and produce better long-term returns.
Think of it like buying a car. A Hyundai is cheaper than a BMW. But many people nonetheless choose to pay more for the BMW, depending on the features they are seeking in their new car. Price is an important factor, but it’s never the only, or even the most important, factor.
That’s why we often prefer to use a mix of active and passive investments in your portfolio, depending on your objectives and the goals we are trying to achieve. The good news is that low-cost ETFs give us a valuable new tool for our investment toolbox, and you’re certain to benefit.