Index Funds vs Active Management: Cost vs. Cost-Justification

Lots of talk these days about making sure you have low-cost mutual funds.  All things being equal, yes, the lower the internal costs of a fund, the better.  Assuming, that is, you are talking about funds that invest in the same way and get similar returns...

But all funds are not equal and do not all invest the same way.  Some fund managers are better at picking investments, and they get better returns.  You can do better if you choose those benchmark-beating funds.

Think of a football team...  the same playbook and strategy would be more successful most of the time if all-pro players were on the team.  That is what my Strategic portfolios aim to accomplish--the mutual fund versions of a team with "all-pro players" on the field for us.

These "all-pro" funds cost more than the low-cost index funds, but that should not matter if their net performance is better.  If one fund delivers net-of-fees performance of 7.5% per year and another 7.0%, why be concerned about how much each fund charges?

Uncertainty is the only reason--we don't know if the outperformance will continue.  But if we find funds with consistent track-records over several market cycles, we can have confidence that they really are better at investing.

But these funds are hard to find.  80% of actively-managed funds underperform their benchmarks.  How does one know which are in the 20% that outperform?  Can't figure that out for yourself?  I will do it for you for about 1.25% per year.  I know what to look for, and I have the tools--my firm's most expensive overhead cost is the research database with which I hunt for the actively-managed mutual funds that are worthy using.

And even if the cost-justification makes it merely a wash compared to using index funds, you still have me on retainer to help with personal financial strategy and advice:  how much to save, which accounts to use, buy or rent a home, lease or finance a car, what kind of insurance to buy...


There is Nobel Prize-winning research that guides most financial advisors on how to diversify portfolios.  If we're following that asset allocation guidance, then portfolios using benchmark-beating funds should do better most of the time and over the long-haul than those using index funds, even if the latter have lower costs.  The Strategic portfolio models I offer will have beaten strategically similar models comprised of index funds, and over just about every time period.


To summarize, index funds are all pretty much the same, so go for the ones with the lowest cost...  but a well-constructed portfolio of the best actively-managed funds should beat that, and even if you don't know how to do it yourself, an advisor like me can do it in a way that cost-justifies the additional advisory fee.  Value.  Cost-justification.  Good stuff!

I appreciate your time.  Thank you for reading this post.

Where Do Millionaires Get Their Money?

Most get their money by working, earning and saving.

80% of US millionaires are the first-generation of their families to get to that level.

Only a very few of them are celebrities and athletes and Wall St all-stars. Most of them are just like you and me, but with a bit more luck, or a better idea, or a better work-ethic. Or a better savings/investment plan...

If you save 5% of your income, you'll have some extra money in retirement to supplement Social Security and any pension you might have. If you save 15%, there's a very good chance you'll be a millionaire.

Talk to me about your strategy. It's what we do, and it works.

Retirement Account Contribution Priorities

You have a job. You can pay all of your necessary bills each month. Now you want to save for retirement. Good. You should!

But how? So many different accounts, so many ways to save.

Well, I'm here to help. And today let's forget about the investments. Let's just focus on where to put the money.

Here are the usual retirement savings choices:
1) employer-sponsored retirement plans (like 401k, 403b, TSP, 457b, and pensions)
2) individual retirement accounts (IRA, Roth IRA)
3) taxable brokerage accounts

All of these accounts allow you to hold cash or invest. Investment options vary, but typically you can at least use mutual funds.

Options 1 and 2 offer tax-deferred investment growth, and you may also be able to deduct your contribution amount from your taxable income each year.

Option 1 sometimes offers additional contributions from your employer--a very nice fringe benefit!

So, how to do all this?

First, take the "free money". If your employer offers "matching" or "profit sharing", contribute enough to earn the maximum offered. That's a no-brainer, but I'm saying it anyway!

Second, if you are eligible to contribute to a Roth IRA, do it. Any investment growth is free of capital gains taxes, AND the money comes out of the account tax-free in your retirement years. You can put in up to $5000 per year ($6k if you're 50+ yrs old). If you can't use a Roth IRA, then go to the next step.

Third, go back to the plan at work and top it off. You can contribute up to $16,500 per year. If you make $100k and get a "match" on the first 6% of your salary contributed, then you put in $6k right away. Then you put in $5k to the Roth. So, here now you can put in another $10,500 into the plan at work.

Fourth, if you can't use a Roth and have more than $16,500 to save each year, now is when you should fill-up your traditional IRA. $5k max per year, $6k if you're 50+.

Fifth... it gets complicated, and most folks do not get this far. But try!

If you can afford to save into the 401(k) and the IRA--a total of $21,500 per year--congrats! You are among the few and the proud.

If you make less than $200k per year and you are saving over $20k per year while still in your 30s, you are definitely on the right track.

If you're one of the so-called "rich" earning more than $250k per year, though, you may still need to save more. Think in terms of at least 10%, preferably 15%, and if you're getting a late start, 20% of your income should go into your retirement accounts.

Call me and we'll run a retirement projection so ballpark whether or not you're on track.

Mutual Fund Costs: Saving Money While Making Money

Most of us use mutual funds for our investment portfolios. We get professional management and diversification that way. If we had millions of dollars, we could afford private portfolio management in order to obtain those important benefits.

Either way, there are costs. Some funds, or managers, are more expensive than others. But funds and managers generate unique investment performance, and they establish unique track records. So, cost alone is not the right factor to consider when selecting our investments.

It really should be about "cost-justification". I've said this here before, but I just read yet another magazine article that I think sends the wrong message: "Shop around for inexpensive investment options in order to maximize returns."

That's dubious advice. When put that simply, it will lead folks to use only the cheapest funds.

Let's compare two very popular mutual funds and test that advice: PIMCO Total Return C (PTTCX) vs. Vanguard Total Bond Market Index (VBMFX), both of which are bond-oriented mutual funds intended to provide broad exposure to income-producing, low-volatility fixed-income investments. Neither charges a front-end sales "load", and they have almost the same amount of volatility/risk.

PTTCX has a pretty high "expense ratio" of 1.65%. This would make Suze Orman pretty emotional.

VBMFX has a very low "expense ratio" of .22%. This would make Suze Orman pretty happy.

PTTCX vs. VBMFX over the past 10 years? 6.46% per year to 6.10% per year. PTTCX wins!

Over the past five years? 6.29% to 5.55%, and PTTCX wins again.

Three years? 9.77% to 7.45%. PTTCX, again.

The last 12 months? 10.82% to 8.00%. PTTCX

And how about the last month? 1.33% to .84%. Yes, PTTCX won again.

(all of those returns are inclusive of the "expense ratio", or "net of fees")

That's a great example of "cost-justification vs. cost alone". And something else to consider is this: VBMFX is an index fund that must stay fully-invested all the time in a specific group of investments, while PTTCX can keep money on the sidelines or move around within the fixed-income arena to avoid problems or take advantage of opportunities. While that would be a problem if PTTCX "bets wrong", that fund has an extremely long and successful track record.

Now, this is the rare case, but don't let its rarity deter you. You should pursue the best product available. Sure, about 80% of mutual funds fail to beat their benchmarks, but you can find out on your own which ones do beat their benchmarks.

Or, you can hire a financial advisor to figure that our for you. Not all of us are diligent about it, but some of us really are, and it's to your benefit.