History of Fees and Expenses
When we first started these trust funds twelve years ago, investing in stocks was expensive. It cost $25 to buy a stock or to sell a stock (although we rarely sold, since we were and still are trying to “buy and hold” more often than not), and they issued portfolio fees of $30 / year just to have an account.
At the time there were TV commercials about “Stuart” from E-Trade who was helping his boss to learn to trade himself, online. Up until this time sales were mainly made by calling your broker who would put in an order on your behalf. It seemed “space age” to purchase stocks this way, and potentially dangerous. The internet was in its infancy (for the general audience), and it seemed better to talk to a person and get back your information in a printed statement.
Cost of Trading in These Portfolios
A recent article in the NY Times called “Give Fees an Inch, and They’ll Take a Mile” describes the impact of fees on long term investing:
Fees may seem inconsequential at first “but over time they can have a very profound effect on investment returns.”… a 1% annual fee on a $100,000 portfolio that grew 4 percent annually over 20 years. Without any fees whatsoever, the portfolio would have grown to $220,000… a 1% fee subtracts $28,000 from the portfolio… and the lost return on the $28000 devoured by fees… is $12,000. All told, then, 1% in annual expenses would have eaten up roughly $40,000, or about one-third of the total $120,000 return on your investment. Ouch”
Note that this 4% return is BEFORE TAXES, which can take a nominal amount (if you are a kid and don’t have earned income) or as much as 40%+ if you live in a high cost state and are in an upper tax bracket. And then there is inflation, which is likely running at more than this in “real terms” (when you factor in health care, college costs, etc…). So there isn’t usually that much left anyways, and fees / taxes / inflation are the three horsemen that you try to minimize (although you can’t do anything about inflation except for debt / purchase changes which are far beyond the scope of this post).
The cost of online trading and setting up an account has plummeted over the years. Due to the way these funds are set up (they are kind of a subset of my accounts), they receive up to 25 free trades a year, which is a number that is many more than we will ever need per account, so trading is effectively free. And while they issued fees on the accounts ten years ago, they don’t do that any more, either.
Your mileage may vary depending on how your brokerage account is set up but these portfolios are effectively being run at zero cost. The brokerage firm offers very low interest rates (near zero) on cash held in money market accounts, but this is the norm in the entire industry. I can proudly say that on at least one dimension of investment returns – fees and expenses – these trust accounts for the beneficiaries beat (or tie) everyone, everywhere at a cost of zero. Funds 4, 5 and 6 have never paid any expenses at all and funds 2 and 3 paid a minor amount. Fund 1 paid some early on but hasn’t paid in many years so this is adding up to a smaller and smaller portion of total assets under management (as we average many years of zero expenses against the early years).
Only a lunatic like me would pore through the funds, looking for every single expense, and calling them out. Researching the brokerage statements and essentially designing newer, more useful ones is what I have been doing – most statements don’t tie dividends to the respective stocks that are providing the dividends, nor due they keep tabs on sales for many years’ after they’ve occurred (a sometimes painful introspective process). Everything that happens on your statement has a purpose and a reason for existing, and I find it interesting to look at all of the costs and money moves along the way.
The stock providers don’t make it easier (the firms) by doing things like stock splits and attempting to buy up the “odd lots” which are less than 100 shares. Over time as some of the portfolios (like one) get larger and where it is possible I am buying in rounder units like 50 or 100 shares if possible but the fact that there are odd lots is a problem for the firm, not for me. 100 shares times $20 / share means a $2000 single purchase so that won’t happen for most of my stock buys. In addition, we have stocks with values of more than $100 / share in the portfolio which means an odd lot is anything less than $10,000. Stock splits are a general annoyance, since they cause the basis for tax to change and then you need to adjust prices. Often when there is a stock split there is a small purchase of fractional shares but they are too negligible even for me, the nit-picker of financial statements, to track.
I can also quickly and easily see the portfolio performance using Google Finance. it is quick to set them up with pricing and transactions and then market moves are reflected when you look online at a glance. You just need to track dividends separately and do the buys / sells and adjust the cash but that doesn’t take long (you probably can let Google Finance do this for you but I don’t). This is usually how I find out about stock splits because Google Finance automatically adjusts for these items.
Taxes have also gotten much simpler. The firms now track “cost basis” when you purchase stocks, so when you make a sale, it will calculate your gain or loss and classify it for you as short or long term. This only applies to stocks purchased in the last few years, although they will go back and put in the rest of your portfolio if you bug them (they did for me, at least). Although only an eagled-eyed nut like me would go back and look at the purchase price of a stock that had been split; my records didn’t match with their cost basis; likely they took the “end of day” price for that date when determining my cost basis rather than the actual price paid for the stock divided by 2 (it was a 2/1 stock split). But we will go with their number the difference is nominal. I like finding issues like that because it shows that I am learning more about this process in detail.
What You Get With the 1% Elsewhere
What isn’t included in these portfolios is compensation for me, the person that researches the stocks, recommends when to trade, and puts together the detailed analysis that you can see in the spreadsheets in the links to the right tied to each portfolio. I estimate that I put in about 25 hours / year into work on these portfolios, which actually is a significant portion of my time that is available after work which usually bleeds into the weekend, as well. It would probably be reasonable for me to charge a 1% “portfolio fee” each year to account for this, which would be about $800 / year or so and rising as these portfolios hopefully total up to closer to $100,000 over the next few years.
However I don’t have a current intention of charging my time to these portfolios, since I set them up with the purpose of raising interest in stocks and investing to my nieces and nephews, and it has had a salutary positive effect towards that goal. It is useful for me to think about these services and to look at how I perform them vs. other options that we could have for these funds. You could also think of it as part of my “contribution” to the beneficiaries, along with the investment and match which occurs annually.
ETF’s and Mutual Funds
Another alternative is to go to ETF’s or mutual funds. Individual stocks are very cost and tax efficient because if you are smart you can match the buys / sells together to minimize capital gains and do this explicitly. If you get free trades in your brokerage account, you can essentially do all of this for zero costs.
You can trade ETF’s like stocks, but there is a fee embedded within your ETF. This lets you time sales and determine gains and losses but some of the modern ETF’s on broad markets have fees that are less than 10% of 1% or 0.001. At this point the fees are very low and almost negligible. Other ETF’s have much higher fees, but sometimes that is the only way to get exposure to broad indexes or certain foreign countries. Certainly you need to understand what value you are getting for ETF’s. We may recommend some ETF’s as “stocks” in these funds in the future; one year we recommended the South Korea ETF (it is hard to buy most of their companies by ADR and I didn’t want to trade directly in South Korea, although I might some day) but no one bought it that year.
As far as mutual funds, I have some but they are old. I might consider some for debt but they are not efficient investing vehicles because they throw off gains and losses and have other issues. New mutual funds have very low fees, however, in some cases so it is not very material. But I would never recommend buying new mutual funds if there are ETF alternatives.
Expenses matter, especially in an era of low expectations for returns. This SEC example cited above in the NY Times article assumed a 4% return; if this article was written in the 1990′s they’d probably assume 10% returns in their example.
For these portfolios we have been able to get expenses down to near zero due to the way the brokerage account gives out free trades and how we trade some, but not a lot, in our accounts. Finally I provide services to the portfolios but don’t charge that you’d probably need to pay unless you just went straight with simple ETF’s and left them there.