Long-Term Investing, 21st Century Style

20TH CENTURY INVESTING

For most of the 20th Century, this is how people saved for their retirement (or other long-term goals such as a college fund). You took your money to an investment advisor/broker. The advisor would do some research (hopefully) to develop and maintain a portfolio of investments suitable to your situation (usually managed mutual finds).

In return for this research and maintenance, the advisor would receive commissions from the funds. Specifically whenever there was a sales charge (load), some of the load collected was kicked back to the advisor; and whenever quarterly or annual expenses were assessed as a percentage of assets held (the expense ratio) the fund manager also received a portion of that assessment. Furthermore, some advisors would charge a flat annual fee directly to the investor.

The portion of sales charges and annual expenses that did not go to the advisor, stayed with the fund to pay the fund’s own management costs. These costs included the research done by the fund to select and maintain its underlying stocks or bonds.

Sales fees are typically 5.75% of the purchase, and annual expenses vary widely, but naturally the funds that many advisors offer carry expenses amounting to 1% to 2% annually, which is on the high side.

401(k) plans take the commissioned advisor out of the loop, so sales charges are often waived and expenses drop below 1%. But for managed funds, the managers still want no less than 0.5%.

21ST CENTURY INVESTING

This is how an increasing number of investors are saving for their retirement (or other long-term goals such as a college fund). You take your money to a fiduciary investment advisor. The advisor would do some research (hopefully) to develop and maintain a portfolio of investments optimal (not merely suitable) to your situation. This research may involve the advisor accessing computerized algorithms to generate the optimal mix. Usually the advisor will come up with passively managed index funds, either in the form of mutual funds or Exchange Traded Funds (ETFs).

In return for this research and maintenance, the advisor would receive nothing from the funds. A fiduciary, by definition, cannot accept such kickbacks, neither from sales nor annual expenses. The advisor is paid only by the investor, who pays either a percentage of total assets, or an hourly fee, or perhaps a flat fee.

None of sales charges and annual expenses go to the advisor, and instgead stay with the fund to pay the fund’s own operating costs. Since the underlying stocks or bonds in an index fund are already defined, there is no research to sponsor, and the only costs are for trading the underlying investments to keep the fund in synchrony with its index.

The result is expenses are very low. The funds’ expenses themselves are often below 0.2%, and the only major expense is the advisor’s fee, typically runs between 0.7% and 1% annually.

Some enlist completely computer-based fiduciaries called robo-advisors to build their portfolios. The computer system is set up to run the same massively detailed analysis for each investor (varied according to how much time until retirement).

An ever increasing number of investors, leveraging the knowledge of the Internet, are choosing to be their own advisors. This way you’re guaranteed a fiduciary advisor, with no advisor fees. Still, the cost is some time, but it doesn’t have to be time slaving over research into mutual funds and stocks, but rather learning how to stack up index funds to align with your objectives. I happen to be one of the do-it-yourself investors. My new blog will discuss the ideas behind the decisions I make.

AUTHOR’S PERSPECTIVE

The “old” approach costed a lot. This approach was valid as it enabled many individual investors to retire with financial security, but at the same time the individual’s advisor would retire quite comfortably, not to mention extremely so for the mutual funds’ managers. But the new approach is closer to optimal, because it removes a lot of ancillary expenses.

Investments usually are not FDIC-insured, appreciation is not guaranteed, and your investments may lose value. I go further and say your investments will lose value at some time. If you lose all or part of your life savings following a decision you’ve made based on my suggestions or theories, it’s your own dumb fault for trusting some random blogger on the Internet!