How much do costs matter?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
qwertyjazz
Posts: 1026
Joined: Tue Feb 23, 2016 4:24 am

How much do costs matter?

Post by qwertyjazz » Sun May 29, 2016 9:02 am

I get how a 100 basis points can effect a portfolio over time. I was wondering in a world where er have been dropping for decades on index funds, how do people who have have experienced that over the years approach cost? In some ways the TSP debates over a couple of basis points seem strange considering how much it cost Mr Bogle to put together his first index fund. Do people use heuristics, historical memory, exponential expansions, spreadsheets, not care for a couple of points?
G.E. Box "All models are wrong, but some are useful."

User avatar
SimpleGift
Posts: 2617
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

Re: How much do costs matter?

Post by SimpleGift » Sun May 29, 2016 9:29 am

qwertyjazz wrote:Do people use heuristics, historical memory, exponential expansions, spreadsheets, not care for a couple of points?

Personally, the impact of annual fund expenses was easy for me to grasp, as whatever fees that went to the fund managers came directly out of my investor returns — simple arithmetic. However, it wasn’t until I saw this table below from Vanguard that I actually grasped the cumulative, compounded impact of investment expenses:

This table was an eye-opener and I printed it out and taped it on the wall above my desk — a personal heuristic, if you will. Even a small, 0.10% difference in fund expenses has a significant impact on one's ending wealth after 50 years.
Cordially, Todd

dbr
Posts: 23750
Joined: Sun Mar 04, 2007 9:50 am

Re: How much do costs matter?

Post by dbr » Sun May 29, 2016 9:43 am

qwertyjazz wrote:I get how a 100 basis points can effect a portfolio over time. I was wondering in a world where er have been dropping for decades on index funds, how do people who have have experienced that over the years approach cost? In some ways the TSP debates over a couple of basis points seem strange considering how much it cost Mr Bogle to put together his first index fund. Do people use heuristics, historical memory, exponential expansions, spreadsheets, not care for a couple of points?


As seen in the spreadsheet posted above the effect of costs is easy to see in a simple calculation. Therefore one finds among the available investments those for which the cost is as low as reasonably possible and where the loss due to cost is very small. It is easy to see that 0.1% or so is both available and sufficient to mitigate the problem. I am not sure what your question is. Since you mention 1% costs does that mean you are trying to decide that 1% is somehow ok because that is a choice you have and you want to take it?

There are cases in 401K for one where costs may be too high but it is a reasonable argument that employer matching and tax benefit are worth paying for assuming the money can be rolled out eventually or that the plan will improve.

qwertyjazz
Posts: 1026
Joined: Tue Feb 23, 2016 4:24 am

Re: How much do costs matter?

Post by qwertyjazz » Sun May 29, 2016 9:51 am

I mean the 2-5 basis points that might change flexibility in making a decision or where there maybe improved customer service or maybe the 10 basis points that reflect change in AA or location of assets.Thank you

http://www.fool.com/mutualfunds/indexfu ... unds01.htm

Mr Bogle proposed that a 50 basis point cost vs a 200 basis point cost would matter from my limited understanding.

dbr
Posts: 23750
Joined: Sun Mar 04, 2007 9:50 am

Re: How much do costs matter?

Post by dbr » Sun May 29, 2016 10:04 am

qwertyjazz wrote:I mean the 2-5 basis points that might change flexibility in making a decision or where there maybe improved customer service or maybe the 10 basis points that reflect change in AA or location of assets.Thank you


These are "it depends" questions. Customer service is not a quantifiable variable. Most likely after you have had a bad experience with customer service at some broker paying 2-5 basis points to go elsewhere would be a decision made in heartbeat for some people. Other people are impervious to garbage. Even if a customer service fiasco cost you actual money there is no way to predict repeat offenses. Flexibility would presumably involve putting a cost on time and inconvenience. It could well be worth paying 2-5 basis points for that. If you are talking $1M, then 5 basis points is $500. If your time is valued at $50/hour is the cost ten hours of your time? That is only one hour if the investment is only $100K. I don't know how to put a cost on aggravation.

You would have to give a specific example to show how costs are trading off with asset allocation.

qwertyjazz
Posts: 1026
Joined: Tue Feb 23, 2016 4:24 am

Re: How much do costs matter?

Post by qwertyjazz » Sun May 29, 2016 10:27 am

I like the conversion to time value of money. I would probably have to make a mental estimate of likely issues going forward and compounding of benefits vs frequency of time and some personal annoyance factor. TSP has limited withdrawl and conversion options. By AA I meant how should costs factor into decisions of tilts or should it all be the same fundemental questions we struggle with when deciding on them. If one considers costs, then overtime that has become less of an issue.or also if one considers hold commodity tracking funds in order to allow rebalancing. Thank you this has helped me.

magneto
Posts: 882
Joined: Sun Dec 19, 2010 10:57 am
Location: On Chesil Beach

Re: How much do costs matter?

Post by magneto » Sun May 29, 2016 10:33 am

Costs do matter as highlighted so dramatically in the table posted above.

Given the choice between two cap-weighted funds tracking the same index, lower cost wins every day.

Now the buts!

1. Certain parts of the world or sectors or tilts can be difficult to access with trackers alone. There again costs matter but must be balanced with any benefits brought to the portfolio.
2. Rebalancing Method Benefits can by far outweigh fund costs, and are worthy of at least as much attention.
'There is a tide in the affairs of men ...', Brutus (Market Timer)

qwertyjazz
Posts: 1026
Joined: Tue Feb 23, 2016 4:24 am

Re: How much do costs matter?

Post by qwertyjazz » Sun May 29, 2016 10:52 am

I appreciate all the thoughtful responses. I see the world as heading towards the bottom left corner of that excellent table which simplegift supplied. After 60 years at 5 basis points there is a 3% difference. I am trying to think through how to live in that world vs in that seen in the right hand side of the table.

User avatar
tetractys
Posts: 4579
Joined: Sat Mar 17, 2007 3:30 pm
Location: Along the Salish Sea

Re: How much do costs matter?

Post by tetractys » Sun May 29, 2016 10:57 am

Costs are such a significant factor that I think it might be one reason many investors still invest directly in stocks. Anyone here aware if there's any analysis to back that up?

And for us here, costs probably provide one of the best arguments to avoid any funds, index or otherwise, that have E/R's over, say (guessing) 0.15%. Which points towards simpler portfolios, and sticking to the broader indexes. For the extra effort of tilting, one really needs solid statistics to show that any extra expense can be overcome over the long haul. -- Tet

livesoft
Posts: 56611
Joined: Thu Mar 01, 2007 8:00 pm

Re: How much do costs matter?

Post by livesoft » Sun May 29, 2016 11:05 am

I try to use investments with expense ratios as low as reasonably achievable or ALARA which is a radiation safety acronym. Just like avoiding ionizing radiation like X-rays, I avoid high expense ratios. Nevertheless, I still fly in airplanes and get my broken bones X-rayed.

To put some more perspective on fund expense ratios, one might compare them to other investing costs that one might have. For instance, if one has to pay $10 commission to buy $1000 of shares, then that $10 would overwhelm a small difference in expense ratios for many years of holding the investment. Even the timing of a buy or sell transaction can overwhelm small differences in expense ratios. Failure to tax-loss harvest can overwhelm small differences in expense ratios.

So I don't worry about getting the lowest expense ratios possible and find that Vanguard ETFs are good enough for me. I do use some other non-Vanguard ETFs with expense ratios as high as 0.65% for emerging markets small cap. And I do avoid commissions and taxes.
This signature message sponsored by sscritic: Learn to fish.

dbr
Posts: 23750
Joined: Sun Mar 04, 2007 9:50 am

Re: How much do costs matter?

Post by dbr » Sun May 29, 2016 12:27 pm

One can also apply this famous dictum and not invest excessive time and energy in the last 20%: http://www.investopedia.com/terms/p/par ... A&ato=3000

User avatar
Robert T
Posts: 2448
Joined: Tue Feb 27, 2007 9:40 pm
Location: 1, 0.2, 0.4, 0.5
Contact:

Re: How much do costs matter?

Post by Robert T » Sun May 29, 2016 12:30 pm

.
Two related articles that may be of interest - the first by Bogle.

The Riddle of Performance Attribution: Who's In Charge Here—Asset Allocation or Cost?
Fees matter more than asset allocation

Costs are the only certainty in investing.

Personally, I try to minimize (total) costs (expenses, taxes, trade costs etc) for my target portfolio factor loads.

Robert
.

heyyou
Posts: 2741
Joined: Tue Feb 20, 2007 4:58 pm

Re: How much do costs matter?

Post by heyyou » Sun May 29, 2016 1:02 pm

Thank you for the spreadsheet.

Damning evidence for those with high cost 401k plans, and another advantage of transferring retirement assets to low cost providers when changing jobs or retiring. It also adds some fuel to TSM over slice and dice if the weighting is the same (written while Tet was posting similar info). Somewhat like life insurance commissions, or mortgage payments, those first years of saving go to paying the financial provider, it just looks like the money was saved. Not that Jack Bogle and Edward Abbey had much in common, but both noticed that the biggest buildings in the cities were all built by financial institutions.

What is missing is the dollar weighted costs, and the cost in real dollars.

User avatar
Taylor Larimore
Advisory Board
Posts: 26142
Joined: Tue Feb 27, 2007 8:09 pm
Location: Miami FL

Re: How much do costs matter?

Post by Taylor Larimore » Sun May 29, 2016 1:23 pm

qwertyjazz wrote:How much do costs matter?

qwertyjazz:

The matter a LOT. This is what experts say:
American Association of Individual Investors: "Funds with loads, on average consistently underperform no load funds when the load is taken into consideration."

Frank Armstrong, author of The Informed Investor: "Wrap fee accounts may be great for the ego, but they're bad economics."

Bear amd Gensler, co-authors of The Great Mutual Fund Trap: Many of the costs of investing are practically invisible--you never have to write a check to anyone for fees or commissions."

Bill Bernstein, PhD, Md, adviser and author of The Four Pillars of Investing: "Make no mistake about it, you are engaged in a brutal zero-sum contest with the financial industry. Every penny of commissions, fees, and transactional cost they extract is irretrievably lost to you."

Jack Bogle: "You get to keep exactly what you don't pay for."

Bogleheads' Guide to Investing: "We are accustomed to believing that the more we pay for something, the more we receive. Sorry; this is not how it works when buying mutual funds. Every dollar we pay in commissions, fees, expenses, and so on is one dollar less that we receive from our investment."

John Brennan, former Vanguard CEO and author of Straight Talk on Investing: "You should care about expenses because they directly reduce the return you receive. It's as simple as that."

James Dahle, author of The White Coat Investor: "Costs matter and they matter a lot: If two investors make the same 8% per year before expenses on a lump sum investment and the first is paying 2% per year in investment expenses and the second is paying 0.1% per year, then after thirty years the second investor will have 70% more money than the first.”

Eugene Fama, Jr., Vice President of Dimensional Fund Advisers: "One must conclude that in general a manager's fee, and not his skill, plays the biggest role in performance. The higher the fee, the lower the performance."

Rick Ferri, adviser and author of six financial books: "Let's face it: Most investment companies are in business to make money from you, not for you. Every dollar you save in commissions and fee expenses goes right to your bottom line."

Financial Research Corporation did a study to find out which mutual fund predictor really worked: Morningstar Ratings; past performance; expenses; turnover; manager tenure; net sales; asset size; alpha; beta; standard deviation and the Sharpe Ratio. They concluded: "The expense ratio is the only reliable predictor of future mutual fund performance."

Morgan Housal, Motley Fool writer: "It's hard to believe that with historic average market returns, a 1% management fee will reduce your account balance by almost 40% over 50 years."

Arthur Levitt, former Chairman of the U.S. Securities and Exchange Commission: "The deadliest sin of all is the high cost of owning some mutual funds. What might seem to be low fees, expressed in tenths of 1%, can easily cost an investor tens of thousands of dollars over a lifetime."

Lipper Inc.: In 2012 the average expense ratio for Vanguard funds was 0.19%, which is one-sixth the average funds' expense ratio of 1.11%

Professor Burton Malkiel, author of "A Random Walk Down Wall Street": "Many financial services companies make every effort to obscure the total costs you are actually paying. Every extra dollar of expense you pay is skimmed from your investment capital.

Morningstar:"If there's anything in the whole world of mutual funds that you can take to the bank, it's that expense ratios help you make a better decision. In every single time period and data point tested, low-cost funds beat high-cost funds."

Morningstar:"The other major costs of investing are related to taxes, advice, and investor behavior. These costs are more difficult to control than fund fees and, when added together, can be many multiples what an investor pays out in the form of annual expense ratios."

Motley Fools: "It's hard to believe that with historic average market returns, a 1% management fee will reduce your account balance by almost 40% over 50 years."

Jerry Tweddell and Jack Pierce, authors of Winning with Index Mutual Funds: "Don't assume that because you pay more, you get more. Unlike just about any other business, it's backward on Wall Street: The more you pay for services, the lower your returns are likely to be."

United States Securities and Exchange Commission: "Independent studies show fees and expenses can be a reliable predictor of mutual fund performance."

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

qwertyjazz
Posts: 1026
Joined: Tue Feb 23, 2016 4:24 am

Re: How much do costs matter?

Post by qwertyjazz » Sun May 29, 2016 1:47 pm

Between a Bogleheads portfolio and a non- Bogleheads portfolio they matter a lot. Between 2 Boglehead portfolios, costs matter a lot less. I am starting to think about a heuristic of converting basis points to dollars and look at the Vanguard chart which Livesoft presented. Then I will compare that to whatever advantag I think the extra points provide. Is that a reasonable strategy?

pkcrafter
Posts: 12115
Joined: Sun Mar 04, 2007 12:19 pm
Location: CA
Contact:

Re: How much do costs matter?

Post by pkcrafter » Sun May 29, 2016 2:01 pm

We are getting to the real point about costs vs returns. Regarding Pareto, Robert T is one of the 20% that knows what he's doing when it comes to tilting and load factors. He may well overcome additional costs, but the other 80% run what I would term almost a sure fire risk of hurting performance by the other loss factor--behavior. Improper behavior can easily be far more costly the ERs. In some cases, an investor may be better off paying an advisor, but the advisor would have to be very exceptional and not prone to behavioral errors, and that's unlikely. Without a doubt, for 80% of investors, complex portfolios present opportunities for costly behavioral mistakes--mistakes that will overwhelm low costs in terms of lost returns.

qwertyjazz asks about the difference of a few basis points, and theoretically that could actually make a difference over many years, but I cannot imagine an investor could go that long without some kind of error in judgement. So, small differences in ER don't really matter much. It's far more productive to set up a lower cost portfolio that is easy to maintain and keep your hands off.

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

livesoft
Posts: 56611
Joined: Thu Mar 01, 2007 8:00 pm

Re: How much do costs matter?

Post by livesoft » Sun May 29, 2016 2:09 pm

pkcrafter wrote:We are getting to the real point about costs vs returns. Regarding Pareto, Robert T is one of the 20% that knows what he's doing when it comes to tilting and load factors. He may well overcome additional costs, but the other 80% run what I would term almost a sure fire risk of hurting performance by the other loss factor--behavior. Improper behavior can easily be far more costly the ERs. In some cases, an investor may be better off paying an advisor, but the advisor would have to be very exceptional and not prone to behavioral errors, and that's unlikely. Without a doubt, for 80% of investors, complex portfolios present opportunities for costly behavioral mistakes--mistakes that will overwhelm low costs in terms of lost returns.

Investors can compare their portfolio performances against one or more benchmarks to see if their behavior and/or tilting hurts. Even 3-fund investors are prone to behavioral mistakes and are not absolved from comparing to benchmarks.
This signature message sponsored by sscritic: Learn to fish.

Geologist
Posts: 1105
Joined: Fri Jan 02, 2009 7:35 pm

Re: How much do costs matter?

Post by Geologist » Sun May 29, 2016 2:18 pm

qwertyjazz wrote:Between a Bogleheads portfolio and a non- Bogleheads portfolio they matter a lot. Between 2 Boglehead portfolios, costs matter a lot less. I am starting to think about a heuristic of converting basis points to dollars and look at the Vanguard chart which Livesoft presented. Then I will compare that to whatever advantag I think the extra points provide. Is that a reasonable strategy?


I think you are getting an important point. The difference in dollars and cents per year between Vanguard Investor class and Admiral class (or ETF) for small account sizes is not substantial because the difference in expense ratios is so small. Those differences would only be important with large account sizes (at least $100,000 per fund and perhaps more). You can see this by doing the calculation you suggest or by looking at the table of expenses that appears in the semi-annual or annual report of Vanguard funds.

pkcrafter
Posts: 12115
Joined: Sun Mar 04, 2007 12:19 pm
Location: CA
Contact:

Re: How much do costs matter?

Post by pkcrafter » Sun May 29, 2016 2:27 pm

livesoft wrote:
pkcrafter wrote:We are getting to the real point about costs vs returns. Regarding Pareto, Robert T is one of the 20% that knows what he's doing when it comes to tilting and load factors. He may well overcome additional costs, but the other 80% run what I would term almost a sure fire risk of hurting performance by the other loss factor--behavior. Improper behavior can easily be far more costly the ERs. In some cases, an investor may be better off paying an advisor, but the advisor would have to be very exceptional and not prone to behavioral errors, and that's unlikely. Without a doubt, for 80% of investors, complex portfolios present opportunities for costly behavioral mistakes--mistakes that will overwhelm low costs in terms of lost returns.

Investors can compare their portfolio performances against one or more benchmarks to see if their behavior and/or tilting hurts. Even 3-fund investors are prone to behavioral mistakes and are not absolved from comparing to benchmarks.

Absolutely, but chances of mistakes diminish when knowledge is increased and portfolio complexity is minimized. My point was behavioral mistakes can swamp low expenses when it comes to return efficiency.

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

livesoft
Posts: 56611
Joined: Thu Mar 01, 2007 8:00 pm

Re: How much do costs matter?

Post by livesoft » Sun May 29, 2016 2:35 pm

pkcrafter wrote:Absolutely, but chances of mistakes diminish when knowledge is increased and portfolio complexity is minimized. My point was behavioral mistakes can swamp low expenses when it comes to return efficiency.

Paul

Absolutely agree.
This signature message sponsored by sscritic: Learn to fish.

pkcrafter
Posts: 12115
Joined: Sun Mar 04, 2007 12:19 pm
Location: CA
Contact:

Re: How much do costs matter?

Post by pkcrafter » Sun May 29, 2016 3:58 pm

livesoft wrote:
pkcrafter wrote:Absolutely, but chances of mistakes diminish when knowledge is increased and portfolio complexity is minimized. My point was behavioral mistakes can swamp low expenses when it comes to return efficiency.

Paul

Absolutely agree.

:sharebeer :mrgreen:
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

User avatar
Taylor Larimore
Advisory Board
Posts: 26142
Joined: Tue Feb 27, 2007 8:09 pm
Location: Miami FL

"Road Map for Investing Success"

Post by Taylor Larimore » Sun May 29, 2016 4:53 pm

Absolutely, but chances of mistakes diminish when knowledge is increased and portfolio complexity is minimized. My point was behavioral mistakes can swamp low expenses when it comes to return efficiency.

Paul:

Thank you for another "Gem."

For those who don't know, Paul wrote a wonderful, free, on-line book for the Bogleheads. This is the link:

ROAD MAP FOR INVESTING SUCCESS

Best wishes
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

printer
Posts: 110
Joined: Mon Dec 15, 2014 12:37 am

Re: How much do costs matter?

Post by printer » Sun May 29, 2016 5:08 pm

When I come across two funds that are otherwise indistinguishable, for taxable accounts, I choose the one with the lower ET (expense ratio plus tax cost ratio).

Of course, this never happens. Two particular funds are always different. But ET is one of the things I look at when deciding which funds to use.

One example is IJS vs SLYV. The two funds track the same index. IJS has an ER of .25%; SLYV's is .15%. I use IJS mainly because it seems to be far more tax efficient: .35% for IJS vs 1.16% for SLYV for the last 15 years, according to Morningstar. IJS has about 8x the AUM as SLYV, so I expect more liquidity from it, so I'd expect to pay less due to bid/ask spreads. Also, Rick Ferri seems to have some preference for IJS. If everything were the same as it is now, except that SLYV had the (much) lower ET than IJS, I might use SLYV and not IJS.

User avatar
JoMoney
Posts: 4403
Joined: Tue Jul 23, 2013 5:31 am

Re: How much do costs matter?

Post by JoMoney » Sun May 29, 2016 5:33 pm

NPR Interview with Mr.Bogle wrote: http://www.npr.org/2015/10/17/436993646 ... lios#bogle
"Cost turns out to be everything, It's just what I've always called the 'relentless rules of humble arithmetic.'
Simplicity underlies the best investment strategies. Basic arithmetic works. Keep your investment expenses under control, Your net return is simply the gross return of your investment portfolio less the costs you incur [such as sales commissions, advisory fees, transaction costs]. Low costs make your task easier." ...
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

Clive
Posts: 1951
Joined: Sat Jun 13, 2009 5:49 am

Re: How much do costs matter?

Post by Clive » Sun May 29, 2016 5:41 pm

I've heard some partake in stocks for fun and the benefit of others.

8% nominal, 2% in costs and taxes, 4% inflation, 2% from buying high/selling low. 100% thrill (risk) for zip.

Post Reply