top of page

Invest Like You Know What You're Doing

Have you ever stopped to ponder exactly what happens inside your retirement accounts? Not whether or not the balance is going up or down, but rather what's happening with the nuts and bolts inside the positions, causing the balance to fluctuate. Just like needing several ingredients in a recipe, many different factors are needed in a well-constructed portfolio. But for now, we will only discuss one. Let's focus on expenses.

You may not have known that it costs you money to simply start using an investment product like a mutual fund or an ETF (exchange-traded fund). Most (not all) investment products or "funds" have an annual cost associated with them, payable by you! Enter an age-old argument: Actively- managed portfolios vs Passively- managed portfolios. Simply put, an actively-managed portfolio is one where a fund manager is actively deciding which investments to get rid of or "sell" out of the fund, and which to replace them with, or "buy." This fund manager isn't your average college grad. He or she is often Ivy League educated, well connected, and has an extensive knowledge of economics. This person's education in economics and finance is often put to work trying to outperform the market. The "professional management" he or she provides will almost always be associated with a much higher annual fee or "Expense Ratio". Essentially, you are paying a higher fee to fund the manager's assumed ability to generate higher annual returns.

So what about passively-managed portfolios? Passively managed is simply the opposite of active. You are putting money into an investment like an ETF or an Index fund, and then leaving it alone, preferably for a long period of time. There is no active buying and selling. This fund, depending on what it was built to do, simply tracks a sector or sectors of the market. Since no "professional management" is needed the expenses are generally much lower. So how do you know which strategy is best? Shouldn't a Cadillac Escalade cost more than a Camry? The Cadillac is a much nicer vehicle with more options (although overpriced in my opinion). To answer that question it is best if we rely not on the opinion of others, or even financial professionals, but rather on the facts.

An enormous amount of time, money, and effort has been exerted to determine if the funds with higher expenses are actually generating higher returns. The results of the research? Over 85% of actively managed mutual funds (with higher expenses) fail to perform as well as their benchmarks. As you can imagine, paying 1% extra in expenses per year can add up to an enormous amount of money lost 30 years down the road.

Bottom line: Actively-managed investment products are generally more expensive. The problem is the overwhelming majority of them underperform. Passively-managed investment products are less expensive and generally outperform actively-managed products. Now that you know- consider taking the time to consult a professional to expose unnecessary fee's that you may be paying.


bottom of page