Charles Ellis tells money managers how to win loser’s game
As noted in my Wealthy Boomer blog here, American indexing guru and author Charles Ellis [seen in photo on left] gave Canadian money managers both a history and arithmetic lesson on Tuesday. His point in a nutshell is that annual mutual fund Management Expense Ratios (MERs) of 2.5% or so (in Canada) are “terrible” but even the investment counselling fees of 1% (plus or minus 50 basis points) are also excessive.
These numbers may seem small when expressed as a percentage of assets but Ellis said the way to look at it is as a percentage of the return generated by active managers. So even if the active manager could generate a pre-fee return of 10%, the 2.5% fee takes that down t0 7.5%, so amounts to a 25% reduction of the return: or ten times the 2.5% figure that seems so insignificant. If returns are more likely pre-fee 6 or 7%, then a 1% fee takes it down to 5 or 6%, and amounts to a 15% reduction of return, he said.
Ellis himself prefers market-cap weighted index funds or ETFs of firms like Vanguard Group (which recently set up shop in Canada.) Investors can buy the “market” for as little as 10 basis points (0.1%), which long ago was a figure that customers of money managers were accustomed to pay. But as he related in his Monday talk in Toronto, customers didn’t balk when one firm hiked it to 25 beeps, others followed suit and eventually even a full 1% didn’t seem out of line.
This cost-conscious approach consistent with Findependence Day model
None of this should surprise readers of this blog, since the Findependence Day model cuts costs to the bone by emphasizing use of discount brokerages to cut commission costs, and then implementing trades of ETFs or index funds, the fees of which will range from about 8 or 9 beeps to 55 beeps for most mainstream ETFs, and perhaps a bit more for some esoteric ones. Of course, you can also try and pick your own individual securities, although Ellis would probably call that the “loser’s game,” as per the title of his book, Winning the Loser’s Game.
The third point is that you can still benefit from good advice by engaging a fee-only financial planner who charges by the hour, month, quarter or year, or perhaps by the project (which might be a financial plan or portfolio assessment). You can also go the fee-based route but keep in mind that a 1% fee will be on top of the underlying MERs of the ETFs, which could easily run 1.5% or so. For some investors, especially buy-and-hold investors who don’t trade frequently, a traditional commission-based full-service advisor could make sense from a cost perspective, at least relative to a high-fee-based alternative.
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