A Cost Comparison- The Real Cost of Mutual Funds v ETF’s

Subscribing to my site guarantees you don't miss any new content. Choose either E-Mail Feed or RSS Feed. Thanks for visiting!

Well today marks my triumphant return to the blog after a month away from the keys. All I can say is its good to be back and back with a vengeance.

I’ve spent the last few weeks cleaning up the blog and have made significant strides in resolving most of the technical issues that stopped me in my tracks. Like everything else in the universe, Chance favors will continue to evolve over time.

Lets get down to business…

Many posts ago I talked about offering up a series of posts on mutual funds. Well, I’d like to pick it up there. Over the next few days I will be offering a lot of information on the topic, as well as, links to other sites where you can get even more pertinent information.

An ETF based business model

Today I’m going to share with you my perspective on mutual funds and how I frame the cost of mutual funds, as an investment, to my clients. But first a little background…

Mind you, when I started in this business all I sold was mutual funds and annuities- and I sold a lot of them. At that point ETF’s were in there infancy and I’m not so sure I was even aware of them.

As I gained experience as a financial advisor, I became wary of many of the mutual funds being offered in my bank. (It’s important to note that this was around the peak of one of the frothiest bull markets in history, so everything was gorged, including the cost structure of many a fund)

I became acutely aware of the different fees and expenses that were embedded in many of these mutual funds. I realized clients were the ones absorbing these fees and I thought there had to be a better way, or at least a way of screening and comparing the efficient funds with the not so efficient ones.

Fast forward the clock to present day and I’m as wary as I’ve ever been, little has changed in that respect. As you know, if you’ve been reading this blog, I build the majority of my client investment portfolios using ETF’s. I charge my clients a flat percentage of their asset base (somewhere in the neighborhood of 1% for equities)

Here’s what a client gets for a 1% fee:

• a comprehensive financial plan- a formal financial plan, covering everything from net worth analysis to potential estate planning issues; not to be confused with ‘down home’ financial planning
• a Certified Financial Planner on retainer indefinitely- my clients know they can call me (or see me) with questions or concerns as frequently as they like and we can talk for as long as they like, about whatever they like.
• A diversified investment portfolio- From the financial plan we develop and implement investment strategies that are the engine that make everything go, using the aforementioned ETF’s, at no additional cost to the client.
• Plan monitoring and portfolio rebalancing- keeping track of our performance as it relates to the stated plan goals; watching over the investments and periodic rebalancing.

Often, there can be quite a few other issues that come out of a completed financial plan that are not investment related (i.e. estate planning, life and disability insurance, LTC, etc.) but I’ll save that for another day, as this post is related to the investments portion of the plan.

Now, I broke all of this down for comparative purposes. I think it’s important to show you what a full service, extremely efficient, ETF based investment portfolio (along with all the bells and whistles) can cost a client and what they get for the cost.

The skinny on mutual funds

On the other hand, here are a few things I would say to a client when asked about mutual funds:

• A portfolio of investments made up entirely of mutual funds is generally not as cost effective.
• The average mutual fund has an expense ratio around 1.5%. Right off the bat, you’re paying more than a fee based ETF approach, and all you have to show for it is the mutual funds themselves, minus the professional advice and formal financial plan.
• The 1.5% expense ratio is just the beginning. Many funds have shareholder fees, or a sales load, where a client pays a front end charge (as much as 5.50%) to purchase the fund or a deferred sales charge when selling it.

And let’s not forget the hidden fees, (which are passed on to fund investors) made up mainly of the brokerage commissions that mutual funds pay to place trades. These costs can usually be found outside of the fund prospectus in a document called the SAI (Statement of Additional Information), a document fund families are not required to provide fund investors. For this reason it is rarely seen by most investors.

Few mutual fund investors are even aware of these additional costs. Many mutual funds operate under a very simple premise: Out of sight, out of mind. And don’t worry I’ll have a lot more to come on all these topics later in the week.

Once again, I’m happily talking my bias towards ETF based portfolios; but I feel obligated to say, there really are excellent mutual funds out there. For instance, I said (above) the average mutual fund has an expense ratio in the neighborhood of 1.5%, that means there are many that have expense ratios lower than that, with some lower than 1%.

With that said, I still prefer to build ETF based portfolios for clients, with few exceptions. For more details on why I love ETF’s and the tax efficiency advantages they offer, click on the links.

In conclusion

With ETF’s you more or less know what you get; with mutual funds you really need to do your homework or need the help of a professional when building your portfolio.

At the end of the day, for the most part, ETF’s are a lot simpler to understand, far more transparent and a better fit for clients, in my estimation…

Tags: Advisor Compensation, ETF, Featured, Mutual Funds, Psychology Behind Financial Planning