In our now decade-long low interest rate environment, current expected returns on asset classes are relatively low compared to prior decades when advisor fees and high expense ratio mutual funds were established. It may not have felt too uncomfortable paying a 1% advisor fee when yields on US Treasuries were over 10% and stock market expected returns were at 20+%. However, the current 90-day T-bill rate is 0.01% and the 5-year Treasury rate is only 0.88%. After an advisory fee of 1%, you are expected to lose money on that portion of your portfolio yielding less than 1% and even worse when you include the fund expense ratio. Why do want to pay someone to manage your low-risk assets?
The expected return on the stock market is currently around 8.35% as volatility is near its long-term average. In the table below, expected returns for portfolios with varying stock and bond compositions are provided. All bonds at 1.6% and all stocks at 8.35% with combinations at 40%/60% and 60%/40% stocks/bonds in between. As one would expect, the higher the stock percentage, the higher the expected return and risk. The next line takes a little off for using low-cost exchange traded funds for the stock and bond portfolio as a do-it-yourself (DIY) investor.
*Total IG bond market index fund: BND ETF 1.6% YTM and .035% expense ratio, total stock market index fund 8.35% expected return: VTI ETF .03% expense ratio.
**Average annual expense ratio of active funds is 0.66% (Source: Annual Morningstar Study June 2020). Average annual financial advisor fee for $1,000,000 AUM is 1.02% in 2020-2021 (Source: AdvisoryHQ). July 27, 2021: 3-Month T-Bill = .01%, 5YR Treasury = 0.88%, 10YR Treasury = 1.63%, 30YR Treasury = 2.30%. Stock market risk premium = 8.34% (Table 5.4 in Bodie, Kane and Marcus, Investments, 12th Edition.
What is your incentive to become a DIY investor/wealth manager? The average advisor fee plus the average actively managed fund expense ratio is 1.68%. Subtracting that from each of the stock/bond portfolio strategy expected returns reduces your net return substantially. In fact, the 100% bond portfolio expected return is -.08%. It is expected to lose money after all expenses, but not before them. That is because the total expenses are 105% of the expected return. Even with the 100% stock portfolio, the total expenses are 20.12% of its expected return. That means a lot less net expected return for the same risk. Gross!
What is the effect of these expenses on your expected wealth accumulation over time? Here we use a simple example of a 30-year investment horizon to retirement for a 35-year-old with $100,000 plus the commitment to contribute an additional $15,000 per year for the next 30 years. The index fund strategies, net of the fixed low-cost Ripsaw® Wealth Tools subscription service for implementation, has a considerable positive accumulation for all portfolio strategies, including the 100% bond portfolio. Next, we can see the huge drag on wealth accumulation with advisory fees and active expense ratios. Note that this does not even include the strong evidence that the vast majority of active managers underperform their benchmarks with poor investment performance (unnecessary risk to you).
We can express this drag two ways. Either way it is huge! First, the percentage loss of wealth accumulation from excess expenses ranges from -25.21% to -32.16%. Alternatively, the wealth accumulation gain from moving to DIY wealth management with Ripsaw® Wealth Tools has an improvement that ranges from 33.7% to 47.4%. In the 100% stock case, that is going from $2,162,590 to $3,187,621 or over a million in gain or savings! This result is both from the sum of annual expense savings and the opportunity to reinvest those savings.
The bulk of the wealth management universe has been able to charge high fees because of their information and technology advantage over their clients. Do-It-Yourself (DIY) investors have lacked the data access and analytics for efficient portfolio management. Ripsaw® Wealth Tools is the first to provide an independent, disciplined wealth management process that combines auto-updated account information, access to risk dimension data and financial analytics in a low-cost subscription service for portfolio construction, monitoring and revision decisions. NOT a percentage of assets under management. The benefits of our approach are enormous in terms of wealth accumulation and the satisfaction of taking control of your financial life.
Financial security, like health security, is a major stress reliever. Ripsaw® Wealth Tools provides flexible custom modeling for the low price of a Netflix subscription. Isn’t your financial security at least as important as a Netflix subscription?
Stanley J. Kon is Chairman of Ripsaw LLC where he oversees research, education, and product development. He also is the editor of the Journal of Fixed Income. Dr. Kon has written extensively in the areas of investment management, performance measurement, asset pricing, statistical models of stock returns and mortgage-backed securities. He has published articles in the Journal of Financial Economics, Journal of Finance, Journal of Business, Journal of Empirical Finance, Journal of Fixed Income and Financial Analysts Journal. He served as the J. B. Fuqua Visiting Professor of Finance at Duke University’s Fuqua School of Business where he taught courses in fixed income securities and risk management. He was also a Visiting Professor at New York University’s Stern School of Business where he received the Executive MBA outstanding teacher award. Prior to that, Stanley was a principal, executive vice-president, director of research and co-director of the investment management group at Smith Breeden Associates, Inc., an institutional investment management company. Prior to that, he was a Professor of Finance at the University of Michigan from 1982-1997. Prior to 1982, Professor Kon served on the faculties of New York University, the University of Chicago and the University of Wisconsin at Madison. Dr. Kon has also served on several bank and holding company boards and as a consultant to government, business and financial institutions. Dr. Kon received his BS in Chemical Engineering from the Lowell Technological Institute, his MBA in Finance and Economics from St. John’s University and his PhD in Finance from the State University of New York at Buffalo.