As an investor, the only thing that matters more than how much you earn on your investments is how much you keep. Whether you're looking to compound your money for future needs or spend it today, the more efficiently you manage your money, the more of it you'll keep.
Over the long haul, even a couple of percentage points can make a huge difference. Say you're planning on investing $500 a month for the next 30 years and hope to match the stock market's long-run returns of around 10% annualized. Depending on the total costs associated with your investments, your net returns may look like any one of the following:
$500 per Month Invested at
Value After 30 Years
|10.0% net annual returns||$1,130,244|
|9.8% net annual returns||$1,083,143|
|9.0% net annual returns||$915,372|
|8.0% net annual returns||$745,180|
The high costs of inefficiency
A recent CNN Money article showcased a Lipper study that said stock investors tended to lose one percentage point of their annual returns to taxes. That same study said bond investors tended to fare even worse, losing around two percentage points per year, just due to taxes.
Throw fund management fees and trading costs into the mix, and the picture gets even uglier. Hedge funds, for instance, often charge on a "2 and 20" arrangement, or 2% of the fund's assets plus 20% of any returns above a predetermined benchmark. That's a ton of money to pay the fund manager.
Standard mutual funds can also carry high fees that find their way to the fund management companies' coffers, rather than the fund investors' pockets. Even relatively low-priced T. Rowe Price
Do you get what you pay for?
It'd be one thing if the money managers you're paying for earned their keep and provided their investors with superior returns. While there are some, like Legg Mason Value Trust
Take the Calvert Enhanced Equity B
Notice how the lines tend to move more or less in unison over time, except for that big growing gap in total return? That's the difference to your pocketbook driven by the Calvert fund's high fee and turnover structure versus SPY's 0.09% expense ratio and 5% turnover.
That the two seem to move in parallel, aside from those fees, shouldn't be a surprise to anyone who lifts the covers on how that Calvert fund invests. If you check out the top 10 holdings of each, you'd find significant overlap:
Portion of SPY
Portion of CDXBX
|JP Morgan Chase||1.44%||2.89%|
The same big companies hold top spots in both of those funds. Because of that incredible overlap, all else being equal, you'd expect they'd perform similarly. As that chart showed, the funds tend to "wiggle" together, other than the differences driven by the huge gaps between their fees and churn costs.
The tax man cometh
Almost as if to add insult to injury, on top of lower base performance, high-churn funds may expose their investors to higher taxes, as well. A fund with a 109% turnover doesn't hold its positions very long. Gains (if any) are thus more likely to be short-term in nature, thus exposing investors to higher ordinary income tax rates if the fund does manage to turn a profit.
Consider the gap between the 10% and 8% net return levels in the table at the top of this article. Now combine the lower likely returns and higher potential taxes driven by the fees and churn costs. Put the two together and ask yourself if that gap between 10% and 8% might actually be painting too rosy a picture for long-term holders.
Keep your money
Ultimately, the net of what you keep from your investments matters at least as much as the gross returns earned on your behalf prior to taxes, fees, and churn costs. Keep the avoidable costs to a minimum while being invested in companies worth owning, and your net returns will very likely get better as a direct result of your quest to invest efficiently.
At the time of publication, Fool contributor Chuck Saletta didn't own shares of the companies mentioned. AT&T is a Motley Fool Inside Value pick. Apple is a Motley Fool Stock Advisor pick. Motley Fool Options has recommended a bull call spread position on Apple. The Fool owns shares of Apple, JPMorgan Chase, and T. Rowe Price.
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