Wednesday, April 4, 2012

Expenses Matter and Investment Expertise is as Rare as Blue Diamonds

One of my favorite pastimes on the weekend is to listen to financial radio shows as I'm working on projects. Everyone who has one of these shows is trying to sell the listeners something-- financial planning, investment advice, money management, etc. One show in particular caught my attention. The host, as expected, was very confident, had an investment "vision" for the next 3 - 5 years of what sectors/countries would excel and which ones would lag, and touted wonderful results from implemented the advice. Since truth in advertising is hard to come by in the investment community, I decided to do some research.

This radio personality occasionally mentioned a set of mutual funds she ran. I was able to locate them on Morningstar and get some raw information on expenses and performance. Boy was I surprised! These funds carried a 5.75% load. Ouch! They also levied 1.75 yearly expense ratio. So just to break even on the initial investment, the funds would have to return 8.1%. But wait..... that is not all. These funds were actually funds of funds investing in ETFs which incurred their own expenses. The ETF expenses ranged from a low of .40% to a high of .95%. So the effective expense rate of these funds is really around 2.25-2.45%.

But wait...... that's not all. To compensate for this kind of expense structure, these funds should be shooting the lights out on performance, right? Though heavily weighted toward commodities with precious metals ETFs and oil futures ETFs, not to mention shorting the S&P 500 while going long on the Peru and Vietnam stock markets, a $10,000 investment in these funds at inception (approximately a year ago) is now worth in the neighborhood of $7,000, falling quite short of the benchmarks. In fact, in the Morningstar performance rankings they consistently scored in the high 90's when compared to their peer group (1 is the best score, 99 the worst).

The moral of this story is quite simple: don't mistake confidence for competence. Anyone with money can buy their way into a weekend AM radio show. True investment talent is a rare commodity and takes many years to confirm. Most investment folks on the radio are sales people, not investment geniuses. Investment geniuses would be busy investing the money that keeps rolling in due to their successes, not trolling for new dollars from anonymous people listening on the airwaves. These funds may someday catch up with market returns, but they've set a high hurdled to overcome with their expense structure. The smart investor knows that expense ratios are the most reliable predictor of future results.


  1. The radio is a magnet for shysters. I like the ones pitching equity linked annuities. They have perfected the art of playing to the fears of the elderly and the novice investor.
    Listeners need to check claims. Here is an interesting one

    1. I read the Roth article on Edelman and Vanguard a while back. You'd think a self-professed expert like Edelman would know better than shoot his mouth off like that, especially on something that can be so easily refuted...... but then in his case there's that gigantic ego......

  2. The problem that I have with so called investment stars. How can one tell the difference between luck and someone with real talent. Its much harder than you would ever think to tell the difference between investment skill or just luck. A perfect example is gold which was trading around two or three hundred dollars an ounce in 2000. If by coincidence I just happened to buy gold early in the year 2000 and at the same time sold all my stocks that I had owned for three decades. I would look like a investment genius. But all I would have to do to achieve that title is make just a few big moves and be right about them all just luck or skill you be the judge.

  3. The problem with investing in general is theirs a contradiction how does one maintain a diversified portfolio but outperform the market Its not possible. The only possible way to out perform the market is to buy things when their at the extremes of extremes. A very simple example of this is buying a narrow sector exchange traded fund or single country fund {Im not talking funds that use leverage or options to get double returns just funds that own the securities and do not use any leverage} thats down by 80 85 90 even 95 percent from its highs so few investors will step up to the plate and do this thats why they fail to outperform the market.

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