In one of my recent conversations with an employee preparing for retirement, we covered a lot of territory over a number of sessions. In running his retirement projections, he was WAY ahead of the curve. He had his estate plan prepared by an excellent attorney.
His insurance coverages were all right where they should be and at a very low cost. His kids were out of college and he had no more student loans to pay for them. His mortgage was on track to be paid off a month or two before his projected retirement date, and that was not a coincidence.
He had a great plan for his financial life and as a financial planner, it was tough for me to find any area where he could improve. In fact, I suggested that he consider teaching people to do what he did to prepare himself for the future. He was an absolute role model financially.
The only area where I saw room for improvement was in the area of investing. Some of the funds he owned across the 20-25 accounts at various institutions had very high fees and had very high turnover and/or were very poorly rated. Most of his holdings were of high quality but others were worthy of a critical look so that’s what we did….
We’ve all heard the disclaimer “Past performance is not an indication of future results.” Every time I see that my immediate thought is “Thanks! You just gave me info that you admit is irrelevant. Now tell me something that matters.”
If past performance is not an indication of future result, what is? There are more and more reports that show a correlation between low cost and good performance. That seems entirely too logical and simple, but it is true. The lower the fees, the more of your money you get to keep and that can do nothing but help your overall performance.
To find his costs, we entered all of his funds into the “Quote” box at the top of morningstar.com. We then would move to the “Expenses” tab and look at each fund’s expense ratio. He had some funds that were as low as 0.17% (Vanguard 500 Index) and some with expense ratios near 2% (fund names withheld to protect the not-so-innocent). The average fund expense ratio is around 1.4% so having funds that check in at under that level is ideal.
An often overlooked cost is internal trading costs and that can show up in a fund’s turnover ratio. For index funds, you will often see a turnover rate below 10%. For an actively traded fund, you may see turnover rates in excess of 100%, meaning that every investment that they buy during the year has a high probability of being sold. This can generate expenses inside the fund as well as capital gains distributions to the shareholders.
With the free part of the Morningstar website, we were able to gather a lot of information on all of his mutual funds and help him decide what he was keeping and what he was likely not keeping. He also walked out of the office with a better awareness about each individual fund he owned. In a future blog post (don’t you just hate cliffhangers?), I’ll write about how the individual funds, when viewed together, formed a portfolio that surprised him…