The Major Portfolio Threat Hiding In Plain Sight Of Most Investors

Over the last few months, I have reviewed over a dozen portfolios for individuals who weren’t clients but needed more clarity on their current portfolio. Within thirty minutes of looking at their portfolio, we—analysts at my firm and I— can determine the overall risk and forecasted return on a portfolio. Though I never wish to speak ill of other advisors, I have consistently seen one key mistake in people’s portfolios that is losing them far too much and giving them far too little.

When we analyze a portfolio, we do this by stress testing the portfolio against bullish and bearish markets, analyzing its sensitivity to interest rates, and reviewing the expenses. The last of these, expenses, are what is driving me insane (and what I mentioned in the last paragraph)! Let me explain.

There are three types of expenses that most people incur:

  1. An Advisor Fee. This is the fee that you pay a manager to manage your money, manage risk, provide planning, etc. Hopefully you have a fiduciary who you are paying an annual flat fee of 1 – 1.5%. You should know the fee that you are paying. It should not be a surprise.
  2. Commissions. This is the fee that the brokerage charges for you to buy and sell a stock or option. Depending on what you’re buying or selling, you may be able to keep this at a minimum.
  3. Fund Expenses (expense ratio). This is the fee that you pay to own a mutual fund or exchange traded fund (ETF). Behind every fund that you own is a Manager who runs and operates the fund. The fee, commonly referred to as the expense ratio, is the annual fee charged for owning the fund.

The last of the fees is where I’d like to focus. A good portfolio will likely have anywhere from .05 to .25% in annual expenses.

The problem that I have been seeing the past few months (okay, more like the past 15 years!) is that terrible Advisors are loading their clients’ accounts with very expensive funds that eating away potential returns.

Here are a few real-life examples of annual expenses for owning certain funds (mostly mutual-funds). These are a few of the portfolios that I have reviewed for people over the last few months. Remember, the fees in the table are in addition to the annual Advisor fee.

As you can see, some of these portfolios have total annual fees well above 2%, if you include the annual Advisor fee. At the risk of putting too fine a point on it, I’ll say this: that means one would have to get a 2% return (or slightly more) just to break even and keep the amount of their current investment!

Though 2% still may not sound significant, the numbers show that it is. Let’s look at the following example:

Investment Amount: $10,000
Annual Expense: 2%. (This includes both the 1% Advisor fee and the annual expense fee for owning expensive funds.)
Annual Portfolio Returns: 10%

I’ve never given an assignment in our newsletter before, but here we go. I’m giving you this for your own financial future’s sake:

Over the next week find out what your annual expenses are for your portfolio.

If you don’t know how to figure out the fees, or don’t want to spend the time, my team can help. Just click here. There is no obligation from us. We’re on a mission to help people understand their portfolios!

If you find that the fees in your portfolio are .05 – .25%, great! You may not need to make any changes. Maybe you have a good Advisor that is watching out for you.

If you find your fees higher than .25%, then changes may have to be made. At the very least, a conversation should take place between you and your Advisor on how to reduce those fees.

Either way, you will understand your portfolio better than you ever have before.

Here’s to wise investing,

Brett Pattison

What We’re Reading

Howard Marks Masters in Business interview. If you’ve read our newsletter, you should know that we admire a few Portfolio Manager’s. Among them is Howard Marks. In this podcast, there are a few important things that Marks discusses that are closely aligned with our philosophy at Iron Gate. When to buy a stock or other asset, market forecasting, and consistency in your investing approach are the three that stand out the most to us. If you want to understand our investment philosophy better, listen to this podcast.

Sticking with the Herd: A Risky Proposition. Carl Richards on his Behavior Gap blog, discusses the importance of avoiding group think when it comes to investing. As he always does, he presents the idea with great examples and visuals. He addresses risk and the fact that the riskiest investments are the ones that everyone is in. We agree!

These Timeless Investing Principles made Warren Buffett Rich. We buy stocks based on our five-step checklist. One of those criteria is buying stocks with a margin of safety. This article discusses why that’s important and how Warren Buffett implements it. Our favorite quote in the article, “It’s better to buy a great business at a fair price than a fair business at a great price.”

Categories: Personal Finance.