Two financial services firms—Charles Schwab and Wealthfront—duked it out in public last week over whose automated investing service is a better deal. Some may see such sparring as unseemly, but I think it’s great. Such sniping will focus more attention on the surest way to boost returns—cutting investing fees.
In case you missed it, Wealthfront, a “robo-advisor” that uses algorithms to provide very low-cost investment advice, raised a stink last week after Schwab introduced Schwab Intelligent Portfolios, a similar investment service that charges no advisory fee. Wealthfront objected to the ways Schwab earns revenue from Schwab Intelligent Portfolios, including putting a portion of recommended portfolios in “smart beta” ETFs that charge somewhat higher fees than traditional ETFs as well as in cash on which Schwab currently pays a very low rate of return. Schwab defended itself, and lobbed some charges of its own.
I don’t want to bore you any more than I already have with the details of this dust-up (although if you go to the RealDealRetirement Toolbox and scroll down, you’ll find links to their respective salvos). I do, however, want to suggest three lessons you can take from this fee fracas to improve your investing results and increase your odds of achieving a secure retirement.
1. Focus on fees, but don’t obsess over every basis point. You don’t have to work very hard to reap the benefits of low-cost investing. For example, moving from a portfolio of funds whose expense ratios average, say, 1% a year to a portfolio of index funds or ETFs with average expenses of 0.25% can gain you an extra $40,000 or so over the course of 20 years on an initial investment of $100,000, assuming a 6% annual return before expenses. Could you do even better? Sure. These days you can find some ETFs that charge as little as 0.04%.
But at some point shaving off another few basis points here, another couple there and extrapolating the results decades and decades into the future becomes a “fun with numbers” spreadsheet exercise. So by all means create a portfolio of low-cost index funds or ETFs. But don’t feel that you’re losing out if you don’t have the absolute lowest-cost portfolio around.
2. Don’t fritter your savings away by overpaying elsewhere. While you don’t want to devote your life to squeezing out every extra basis point of fees, you don’t want to let savings unnecessarily slip through your fingers either. For example, if you work with a financial adviser, you typically pay two layers of fees: those on your investments, and the fees you pay to the adviser. Depending on how much that adviser charges, much of the savings you reap by moving from a portfolio of high- to low-cost funds could go into the adviser’s pocket instead of yours.
That’s not to say that an adviser who charges 1% or more a year to invest your money is ripping you off. But you need to look at the total amount you’re paying in fees. And you also have to consider whether the services you’re getting from an adviser (investment selection, allocation advice, rebalancing, budgeting, whatever) are worth the money you’re shelling out, not to mention whether you might get the same services elsewhere at a lower cost.
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3. Don’t be awed by “white papers.” If you go to the sites of many robo-advisers, you’ll find white papers and/or methodology statements that quantify in mind-numbing detail how these investing algorithms work and why they supposedly generate better portfolios. Hey, I like modern portfolio theory as much as the next guy, and I certainly believe that there are advantages to asset allocation, rebalancing and harvesting losses in taxable accounts. But I also know that you’ve got to take a lot of this number-crunching with a big ol’ grain of salt. The future may unfold differently than the past, and there’s no assurance that what worked before will work again—or generate comparable results even if it does.
Bottom line: Techniques like mean-variance optimization, rebalancing and tax-loss selling may very well enhance performance over the long run (although I’m skeptical about portfolios that load up on lots of funds and asset classes). But ultimately, the surest way to increase your shot at higher returns and achieving your financial goals is to build a broadly diversified portfolio and keep costs down. And that’s true whether you’re investing on your own or getting help from an adviser, human or not.
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