Dropping the Investment “F-Bomb” … FRUGAL

Posted on Mar 21, 2016

All of us were taught at an early age (some better than others), that dropping an “F-Bomb” was simply not appropriate. In the wealth management circles, however, an alternate way to define what an “F-Bomb” is may be using the word frugal.  Using the word frugal in every day conversation to describe someone’s spending habits is sometimes a polite way of saying they are cheap, and consequently few really care to live and be described as frugal. A wealth manager, on the other hand, should strive to be a client’s number one advocate of frugality, and our firm proudly wears that label on behalf of our clients.

How can a wealth manager be more fee sensitive? One of the main responsibilities our firm takes to heart is preserving and building the wealth of our clients. Investment returns are not the only way to accomplish this goal, and being cost conscious and savvy with our strategies makes a huge difference. Here’s how we aim to save you 1-2% in expenses per year, at a minimum.

Account Optimization – Different types of accounts call for different types of assets to be held in those accounts. In retirement accounts, for example, you typically have a very long time horizon which allows for more risk to be taken. This means it’s usually best to invest these accounts in stocks so that they can grow and compound at a higher rate during the period when there are no taxes paid on their dividends or capital gains. In a standard brokerage taxable account, on the other hand, it’s typically a better account to invest in tax-free municipal bonds. Using municipal bonds not only will you earn tax-free income, but it will put in place a more stable asset that will hold its value during volatile times in the stock market.  Using a structure to invest for growth in retirement accounts and stability in taxable accounts will save you 1.0% to 2.0%[1] each year of your account value due to tax savings.

Investment Fees – It’s no secret that the days of having to own mutual funds with high management fees is in the past, yet many investors seem complacent in taking advantage of this trend. The average fee on an actively managed mutual fund is approximately 0.79%, and the average fee on a passively managed mutual or exchange traded fund (ETF) is approximately 0.20%[2]. Yet we find that comparable investment strategies can be implemented for about a tenth the cost of actively managed funds, and less than half the cost of the average passively managed fund. Expenses are even lower if individual stocks are purchased. This discrepancy is also consistent in other asset classes such as foreign stocks and bonds, where investment choices are plentiful and there’s little argument for living in the past and paying higher fees. We estimate that by implementing a proactive fee sensitive strategy on behalf of our clients, we can save between 0.25% and 0.50% in fees per year.

Tax-loss Harvesting – OK, this is a fancy term, but in practice it’s a practical way of doing things. All this means is that if you have to pay capital gains tax from something that you sold for a profit, try to find something you own at a loss to sell and offset that gain. Even if you don’t have a taxable gain to offset, you still can take a loss on a bad investment (we all have them) and use it to reduce your overall taxable income by $3,000 each year. We estimate that by using a tax-loss harvesting strategy it will save you 0.5% to 0.75%[3] each year in the value of your taxable account.

Custodian Fees – now we are getting down to the nitty gritty in trying to save you money. The institution that holds your investments has a number of ways to charge you additional fees just like banks do with ATM Cards. We advocate a custodian like Charles Schwab where there are no annual fees on accounts, has very low (and sometimes no) commission rates, and allows for next day transfer of funds without charge. All these little things add up.  We estimate that by using a custodian such as Schwab, it will save you 0.1% to 0.2%[4] of your account value annually.

Taking all the above four examples together, from a conservative standpoint we routinely find ourselves in the position of saving clients anywhere from 1-2% annually in expenses on their investment assets. Over many years this can make an enormous difference. It’s not too late to take action!


Posted by on 03/21/2016

Bob Gillooly, CFA is a portfolio manager and enjoys working directly with clients to help plan and implement investment strategies based on a client’s own needs. To contact Bob directly, please call 510-858-2723 or email bob@elmwoodwealth.com