Refinance your investment portfolio

My recently published article in Medical Economics compares the refinancing of a loan into a lower interest rate, to the lowering your investment portfolio's annual investment fees. The type of savings that may be achieved over the long run is similar and can have a major impact on your retirement goals. Whether it is a home loan, student loan, business loan, or even credit card debt, we can all understand how a lower interest rate benefits us and our finances. Yet when it comes to our investment portfolios we typically are not aware of the ongoing "little expenses" we are being charged, and in fact event if we are aware of them we pay little attention to these ongoing fees. This is a major investment mistake and one that most investors make. Reviewing a portfolio for excessive fees is painless and can make all the difference between retiring on-time, and having to work additional years in order to reach your financial goals. Please contact me directly for a complimentary portfolio review, and if you have any questions about this important subject.  seth@orchidwealthmanagement.com   1(650)334-6104

​Refinance Your Investment Portfolio
Seth Swenson, MBA, President at Orchid Wealth Management
 
Most people understand the benefits of refinancing their home loan or student loan. By lowering the annual interest rate, the owner of the home is able to reduce the loan payments and achieve greater leverage and purchasing power. Over the life of the mortgage, the savings in interest payments can be tremendous.
However, when it comes to investments such as mutual funds and exchange traded funds (ETF’s), most people bury their heads in the sand and cringe at the thought of figuring out how to reduce their investment’s annual expenses. This can be a huge mistake.

Consider three hypothetical mutual funds that have the same portfolio holdings. Each portfolio generates an average annual compound return of 7%. The only differences among the three are the annual fees charged to the investors:
Portfolio 1 is charged annual fees of .25%, portfolio 2 is charged 1% and portfolio 3 is charged 2%. The three portfolios start with $100,000 and are invested for 30 years.
Portfolio 1 earns 7% - 0.25% = 6.75%.  At the end of 30 years it will have earned $753,324.
Portfolio 2 earns 7% - 1% = 6%. At the end of 30 years it will have earned $602,257. This 0.75% difference results in $151,049.00 less earnings than portfolio 1.
Portfolio 3 earns 7% - 2%= 5%. At the end of 30 years, it will have earned $446,774.00. This 1.75% difference results in $306,550 less earnings than portfolio 1. The 1% difference between Portfolio 3 and Portfolio 2 results in $155,483 less earnings.
Here’s why fees really matter
Assuming that an investor invests an average of $20,000 per year in their retirement plan, the $151,049 in lost savings in portfolio 2 would require an extra 7.55 years of work. Assuming the investor’s lost savings were $306,550, as in portfolio 3, it would take that person an extra 15 years of work to make up the difference!
Fees can be the difference between an on-time retirement and a delayed retirement. They can even mean the difference between reaching your financial goals and not reaching them.
Many physicians have experienced large amounts of debt such as mortgages, car loans, practice loans and student loans. The illustrations above show how investment fees are similar to the interest rates on loans. Much like the interest paid to a banker, mutual fund fees are money you are paying to enrich the mutual fund company and the broker-dealers selling the funds. Lowering your investment fees is similar to lowering your loan interest rates. It means that you will pay less and keep more of your hard-earned money.
Physicians enjoy their careers and love helping their patients. However, there may come a time when the physician would like to change their daily routine and do something else, such as change careers, hobbies, travel or philanthropy. Physicians want to know that they have a high likelihood of reaching their target date for retirement and their financial target. The chance of reaching these goals is increased when fees are kept to a minimum. Conversely, the chance of not reaching these goals is heightened by paying higher (unnecessary) investment expenses.
What are these fees?
Here’s what some of the most common fees really mean.
Annual Expense Ratio: The annual expense ratio is the ongoing fee an investor pays to the mutual fund or ETF company to operate the fund. The operation of the fund or ETF consists of management costs as well as marketing costs. The expense ratio can be found in the prospectus. There, the management fee and the marketing fee (12b-1 fee) are broken out. Expense ratios can range from as low as 0.05% for an equities index fund to 2.50% for an actively managed fund, a huge 2.25% difference. One mutual fund found with the Morningstar Fund screener has an annual expense ratio of 9.64%.
Turnover Ratio: John C. Bogle referred to turnover ratio as the “invisible cost” in his book, Bogle on Mutual Funds. The turnover ratio is a measure of the annual frequency of trading activity (the buying and selling) of investments within a mutual fund or ETF. The higher the turnover ratio, the higher the expense. This dollar amount can be found in the “Statement of Additional Information” (not the prospectus). As an example, if a turnover ratio is 50%, then the portfolio is buying and selling half of its portfolio’s holdings every year. This means that if a mutual fund has $100,000,000 in assets, then it bought and sold $50,000,000 of assets and it transacted $100,000,000 in purchases and sales. These transaction costs can be considerable.  
Additional expenses: Front end loads (sales charges) typically range from 4% to 6%. Back end loads (contingent deferred sales charges and redemption fees) are sales charges incurred when an investor sells shares of a mutual fund. These charges can be similar to front end loads but decrease over time since 12b-1 fees are charged annually and thus the sales charges are paid for over time. All of these fees are paid by investors to the mutual fund company at different times and are dependent upon which share class is purchased. This information is found in the prospectus.
Passive funds (index) vs. actively managed funds
Index funds generally have lower expense ratios than actively managed funds. This is due to the fact that they do not have to pay a team and a staff of people to actively manage the fund by selecting the underlying investments. The investments are simply selected based on the index they are tracking. Index funds do not typically have loads of any kind. Additionally, the turnover ratio in an index fund is usually quite low, around 5% or lower. The Vanguard S&P 500 Index fund is an example of an index fund, with no loads, no 12b-1 fees and a very low expense ratio.
Actively managed funds have higher expenses since they have a manager, a management team and analysts selecting investments for the fund. Additionally, there are typically 12b-1 fees that are paid to the broker-dealers that sell and market the fund. These extra fees are passed along to you, the investor. The turnover ratio on an actively managed fund can sometimes be as high as 100%.
Passively managed funds and actively managed funds can both be excellent investments. Fees are one aspect of the decision to invest in a mutual fund or an exchange traded fund. Passively managed funds have lower fees and lower turnover and have a lower cost hurdle to overcome. It is also known that over time the majority of actively managed funds have difficulty outperforming index funds.
Some experts believe that because actively managed funds have higher expenses to overcome, the fund managers are prone to taking extra risk in order to achieve better returns. Actively managed funds can be excellent investment choices and the fees can range considerably. So they should be well researched. 
Consider refinancing your portfolio
“Refinancing” your investment portfolio is powerful and may be as important as refinancing your home mortgage loan. Just as there are lower lending rates, there are typically lower expenses available with investments such as mutual funds.
Consider getting a second opinion on your investment portfolio from a Registered Investment Adviser (RIA). RIA’s are fiduciaries (they must always put the client’s best interest first) and do not get paid commissions from third parties. They are likely to give you objective advice and avoid conflicts of interest.
By taking the time to evaluate your portfolio’s expenses and adjusting them accordingly, you may increase the likelihood of reaching your retirement goals on time. Simply reducing your annual investment costs can help you lower financial hurdles and achieve your financial goals sooner and more efficiently.
Seth Swenson, MBA is President at Orchid Wealth Management, a Registered Investment Advisor, providing financial advice to physicians and other healthcare professionals. Palo Alto, California.