High Costs [of Investment Expenses]

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Topic Author
tao
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Joined: Wed Dec 25, 2013 6:45 am

High Costs [of Investment Expenses]

Post by tao »

John Bogle recently wrote an article called the Arithmetic of All in Investment Expenses in which he argued convincingly in the wealth-eroding nature of high investment expenses. Investing in passively managed mutual funds, he argued, can result in a 65% increase in one's standard of living in retirement versus investing in actively managed mutual funds.

Let's assume he's right. At a societal level, though, does this really destroy value in the aggregate or does this instead simply represent a transfer from one group of people to another? Putting aside arguments over whether one group of people such as families saving for retirement deserve greater wealth than another group such as mutual fund managers, traders, financial advisors, brokers, and their families and charities, is society any better off in the aggregate if households invest actively rather than passively or does the whole debate simply center on a transfer of wealth from one part of society to another? i.e. that 65% increase in standard of living suggests that another group of people do not benefit from these additional funds -- the wealth isn't just created ex niholo, right?

-tao
Nathan Drake
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Re: High Costs [of Investment Expenses]

Post by Nathan Drake »

These middle men responsible for extracting wealth from productive citizens represent a net-drain on actual GDP and economic growth. The financial services industry that thrives on active management is not providing anything worthwhile to the economy, and is simply extracting their cut by preying on the ignorance of others.

If the public at large, as well as institutions, stopped lining the pockets of active managers and hedge fund managers, these people would be forced to find productive lines of employment instead, and the general public would be far better off in retirement.
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connor
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Re: High Costs [of Investment Expenses]

Post by connor »

tao
Have you read the parable of The Gotrocks Family?
Leeraar
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Re: High Costs [of Investment Expenses]

Post by Leeraar »

does this instead simply represent a transfer from one group of people to another?
Well, yes. In terms of the old joke:

"My investments sent two children to Yale. Unfortunately, they were my broker's children, not mine."

I have not seen the article you quote, but the arithmetic is compelling. Suppose you invest some sum that earns 6% for 25 years. Your return is

1.06^25=4.29. If you pay 1.5% in expenses, your return is 1.045^25=3.01. Those expenses of "only" 1.5% reduce your total return by 30%.

L.
You can get what you want, or you can just get old. (Billy Joel, "Vienna")
MathWizard
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Re: High Costs [of Investment Expenses]

Post by MathWizard »

Why would this reduce value for society?

If you compare prices and get a car for a cheaper price, have you "cheated" society out of some money?
No. If the companies yio buy from can produce the goods more cheaply, they should be replaced. That is
how we gain in efficiency, and in fact how the GDP rises, from efficiency gains.

Ultimately, rising GDP is what accounts for the gross long-term returns in the stock market.
Without gains in the GDP, we would stabilize on a price for each company or at least for the market as a whole,
and absent inflation or speculation, we would end up with a fixed price based on the dividend rate, essentially
stocks (or a market index) become bonds.

Of course this is my view of things.
Topic Author
tao
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Re: High Costs [of Investment Expenses]

Post by tao »

Thanks for your responses. When you wrote "those expenses of "only" 1.5% reduce your total return by 30%.", the extra 30% in effect accrues to others in aggregate who benefit from your having paid higher expenses. I'm not disputing that you as an individual should want to keep expenses low to not have to transfer wealth to others. However, in aggregate, is society really any worse off? Isn't this just like donating to charity albiet to a group of people society has deemed not worth of alms? And to MathWizard's point, does not this transfer of fees paid actually raise GDP given the additional service rendered? I.e. the only difference between giving to charity and actively investing is that the recipient feels beneficial in one instance and, to Nathan Drake's point, nefarious in the other. However, the mechanics of the transaction look similar: a transfer of wealth with nothing created (lest some additional GDP growth) nor destroyed.

Of course, the "dutch disease" of a resource misallocation toward financial services and away from other, arguably more productive channels for the human capital that the financial industry has siphoned in recent decades may itself represent the dead weight loss to society -- a point I don't dispute. Otherwise, I see the main issue with the weighty fees of active management vs passive management an equity and rent seeking/personal maximization claim in lieu of a welfare advancing claim on a societal level.

Thanks Daniel O for the Gotrocks Family story.
MapleHermit
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Re: High Costs [of Investment Expenses]

Post by MapleHermit »

Nathan Drake wrote:These middle men responsible for extracting wealth from productive citizens represent a net-drain on actual GDP and economic growth. The financial services industry that thrives on active management is not providing anything worthwhile to the economy, and is simply extracting their cut by preying on the ignorance of others.

If the public at large, as well as institutions, stopped lining the pockets of active managers and hedge fund managers, these people would be forced to find productive lines of employment instead, and the general public would be far better off in retirement.
You are absolutely right. Right in so many ways. However, active managers also help a lot of people retire because they market themselves to people who haven't even thought about investing or retirement. They provide financial advising to new families and people who want to build wealth. If they didn't exist, not as much people would invest and the economy would not have as much capital to grow as fast. Although they leech off people, they encourage people to invest which helps those people and the economy as a whole
Leeraar
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Re: High Costs [of Investment Expenses]

Post by Leeraar »

Leeraar wrote:
does this instead simply represent a transfer from one group of people to another?
Well, yes. In terms of the old joke:

"My investments sent two children to Yale. Unfortunately, they were my broker's children, not mine."

I have not seen the article you quote, but the arithmetic is compelling. Suppose you invest some sum that earns 6% for 25 years. Your return end amount is

1.06^25=4.29. If you pay 1.5% in expenses, your return end amount is 1.045^25=3.01. Those expenses of "only" 1.5% reduce your total return end amount by 30%.

L.
Actually, I made a mistake:

3.01/4.29=0.70 - your total amount is reduced by 30%. To compare returns we must subtract the original investment:

2.02/3.29=0.61 - your return is reduced by nearly 40%.

I am not sure this is just some benign redistribution of money. For example, to get the same result after expenses you have to save 43% more. (4.29/3.01=1.43).

L.
You can get what you want, or you can just get old. (Billy Joel, "Vienna")
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