Fees: A portfolio's silent killer

When investors track the performance of their investments, they typically focus on one number: annualized return. It's the obvious choice, distilling months or years of ups and downs into a single data point. It's easy to understand, discuss, and compare. But there's another number, often ignored, with a big impact on long-term outcomes: expense ratio.

If we think of a portfolio as bucket being filled for future use, it's natural to focus on what goes into the top of the bucket through the purchase of securities, plus dividends and price appreciation. But portfolio buckets leak. Fees paid to money managers, mutual fund managers, or ETF managers slowly drain value from a portfolio. These fees diminish positive market results and exaggerate negative ones.

Keeping more of what you earn
The diagram above shows the impact over time of various fee levels on a portfolio's value. With an expense ratio of 75 basis points, a $100,000 investment in the S&P 500 in 1975 would have grown to more than $3.83 million by 2009. At 125 basis points, fees would reduce the 2009 value to $3.26 million. And a 2% expense ratio silently evaporates another $700,000 of portfolio value.

With huge sums dripping out of the bottom of the bucket, management fees deserve far more attention than most investors give them. Fortunately, by choosing investments carefully, investors can greatly reduce what's lost to fees.

At Osbon Capital, we favor index ETFs because they are designed specifically to keep costs low. Intended to track, rather than beat, published indexes, index ETFs do not demand high fees for analysts, economists, and fund managers hoping to outsmart the market through elaborate stock picking or market timing strategies. In fact, many index ETFs keep fees to less than 25 basis points.

As you consider your own portfolio bucket, stay focused on what goes in the top, but don't forget about that leak in the bottom. By keeping it as small and slow as possible, you'll keep more of what you earn.

July 30, 2010

Next time: The fallacy of annualized return.

Contact: John Osbon 617.217.2772 josbon@osboncapital.com

Osbon Capital Management, LLC ("Osbon") is an SEC registered investment adviser with its principal place of business in the Commonwealth of Massachusetts. Osbon and its representatives are in compliance with the current notice filing requirements imposed upon registered investment advisers by those states in which Osbon maintains clients.

This Q&A contains general information that is not suitable for everyone and should not be construed as personalized investment advice. Any historical data presented herein are for informational purposes only and do not reflect actual client accounts.

Example is based on a hypothetical $100,000 investment in 1975, growing at the return level of the S&P 500. Ending values represent portfolio value at year-end 2009 after expenses. Data provided by Morning Star.

Past performance is no guarantee of future results. There is no guarantee that the views and opinions expressed in this Q&A will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. It is not possible to make an investment directly in an index.

For additional information about Osbon, including fees and services, send for our disclosure statement as set forth on Form ADV using the contact information herein. Please read the disclosure statement carefully before you invest or send money. For information pertaining to the registration status of Osbon, please contact Osbon or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov).