Physicians are becoming more and more accustomed to scrutiny of the cost of their services. In an era of healthcare reform, the squeeze is on to reduce margin thanks to pressure from the government, insurance companies, and patients. Declining reimbursements are forcing medical professionals to cut staff, limit time with patients and, in some instances, turn away those seeking specific medical services. Patients are also bearing a greater cost-sharing burden as deductibles increase right along with insurance premiums. Consumer-driven healthcare is here to stay, thus patients have become more aware the actual out-of-pocket costs of medical care. The age of, “It only costs $10 to go to the doctor, so I might as well go.” are extinct. Consumers are shopping for deals on surgeries just the same as they do when buying a new car.
The same cost transparency developing in medical services also continues to gain steam in the investment world. For years, some investors have unknowingly paid exorbitant fees on their investments, creating significant headwind on any return they hoped to capture over the long-term. Government regulation has imposed increasing disclosure requirements on investment companies, funds, brokers and advisors alike to inform their clients of their costs. This change in legislation, coupled with growing investor discontent and pushback, has created downward pressure on one particular cost component: mutual fund expense ratios. According to the Investment Company Institute, industry statistics show stock and bond fund costs are at their lowest level since 1996.
Mutual funds can be described simply as a basket of stocks or bonds assembled by an investment company to offer a more efficient way for individuals to gain diversification. These funds naturally bear some costs to employ a manager to oversee the basket, place trades in alignment with the fund’s targeted allocation, keep records, etc. It is not uncommon for folks to be paying upward of 1% or more – presented in the form of an “expense ratio” (costs divided by assets) – to have their money invested in a particular fund. On top of that, some funds charge an upfront load to make a purchase. These things can get expensive! The problem is that most people are unaware of what they are paying. They don’t get a bill or invoice for the expenses, these costs are simply extracted from the return a client would otherwise receive if the fee was less or non-existent. Since the latter is not feasible, investors should strive to keep these particular costs low. The academic world continues to reveal that the universe of lower cost funds tend to outperform those higher in expenses. The chart below comes from Vanguard and clearly demonstrates the excess return lower-cost funds have achieved versus their higher-cost counterparts across all asset classes.
Aside from that, simple math would suggest the lower your costs, the more money you get to keep and, thus, the higher your return – all things being equal. Additionally, if your fund is considered an actively-managed fund – meaning the manager is trying to time the market and select what’s hot/not – and held in a non-qualified account (non-retirement) you can be hit with significant tax ramifications that show up in the form of a 1099 in the mail. Congratulations, you owe Uncle Sam some money you weren’t expecting!
Be diligent in your questions to your financial advisor(s) and review of your portfolio. Don’t miss out on return you could have had and money you could have saved by ignoring this piece of your financial puzzle. Stay diversified.
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