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Managing the drag on your portfolio

By Dr. Don Taylor ·
Monday, March 17, 2014
Posted: 11 am ET

OK, so this isn't original with me. Vanguard, for example, has done yeoman's work in making investors aware that fees and expenses are a drag on your portfolio's return and that cost-effective investing will improve your net returns.

Consider the dozens of mutual funds indexed to the Standard & Poor's 500. I used the Morningstar mutual fund screener to list S&P indexed mutual funds and found that the annual expense ranges from a low of 0.02 percent (for an institutional fund) to a high of 2.3 percent, a difference of 2.28 percent.

I'll talk about mutual fund share classes in a future post, but the high-cost fund is for C class shares that also has a 1 percent deferred sales load if you sell the fund without holding it for 12 months. Exchange-traded funds based on the S&P 500 index have annual expense ratios of 0.05 percent to 0.07 percent, plus any brokerage commissions. There's no particular reason to pay up to own an index, either as a mutual fund or an ETF.

A mutual fund's tax efficiency also can act as a drag on investment returns. Mutual funds have to pass through to their investors any realized capital gains and dividend income, which creates a tax obligation in taxable accounts.

While you wouldn't expect to see much trading in indexed mutual funds, just adjusting holdings as securities are added or removed from the index, actively managed funds with high turnovers aren't very tax efficient and incur higher trading costs.

If you're invested in your company's 401(k) plan, the plan is required to provide additional information about fees and expenses to plan participants when they start to participate in the plan and annually thereafter. Have you ever reviewed that report? You'll see what you're paying in fees and expenses on your plan investments. It may not be pretty, but it can serve as a call to action, either by changing investment choices within the currently available options or by pressing for change for improved choices and lower costs.

In an earlier post, I talk about "being the market" or "beating the market." The key is to not confuse the two. Don't pay active management fees for a fund that is "closet indexing." For many investors, a core satellite approach -- where index funds are the core of their investment portfolio and a smaller portion of the portfolio is actively managed -- can make sense both for managing fees and expenses and for overall portfolio returns.

How much attention do you pay to your investment portfolio's fees and expenses?

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