Costs really do matter, in every area of life. Not only that, but understanding what is behind the costs is very important. For example, most of us realize that – just like the price of individual stocks or the level of the Dow, which hurtled past 22,000 on Wednesday – the sticker price on a car isn't the result of some sort of divine revelation or a fixed number set by law.
Instead, it's a function of what the manufacturer thinks the car is worth, what the dealer paid for it and what the dealer thinks the car will sell for. Similar concepts apply in investing. One important measure of an investment’s cost is its expense ratio. Generally, studies and comparisons over time have shown that investments with relatively high expense ratios have a harder time achieving alpha.
Of course, expense ratios aren't the whole story. Advisors need to show clients how to consider the total cost of ownership, which includes the expense ratio, but also takes into consideration factors that are harder to assess, such as trading costs and tax impact. Like the insurance, fuel and maintenance expenses for your new car, these less visible expenses have a real impact on the total return.
With equities at high heights, it’s essential to remind clients of their investment time horizons. Multiple studies over several years have confirmed that actively traded accounts — whether mutual funds, hedge funds or other investment choices — fail to outperform their benchmarks over long periods of time. High transaction costs, portfolio turnover and elevated management fees, along with disadvantageous tax impacts, will consistently erode net returns.
Reliance on quality investments held for the long term, along with efficient markets, will usually afford clients superior performance and returns. The financial markets have proven themselves exceedingly efficient at aggregating the sum of all available knowledge into the moment-to-moment pricing of securities. By considering all the expenses involved in an investment carefully, diversifying appropriately and remaining disciplined, allowing the markets to do their work over time and having an investment strategy that matches goals, advisors and clients will be concentrating on factors much more within their control.
WHO’S REALLY IN CONTROL
Remind clients that those who try to time the market or who jump in and out of investments most often succeed only in diluting the power of the market to do what it does best. By trying to control factors that are essentially beyond control, they are setting themselves up for subpar performance.
This is where a good advisor can prove invaluable for investors. By looking beyond the latest hurdle the Dow has passed – or fallen below – an experienced advisor can help investors position their portfolios for long-term performance.