Tuesday, November 22, 2011
Investing Expenses & Returns
I once heard the story of a man who worked as a border crossing guard. During the time he worked there, he would often see one man, in particular, riding a bicycle across the border. The interesting thing about his bicycle was he always carried a box of sand on the handlebars. Needless to say, the guards felt compelled to, usually, check by sifting through the sand to make sure there was nothing there. Finding nothing, they would wave the man through, and let him cross. Week after week, the same man could be seen riding his bicycle across the border. Each time they sifted through the sand in the box, they found nothing. Obviously, the guards found this behaviour suspicious, but were never able to find anything illegal.
Sand, or ...?
Many years went by, and finally, the border guard retired from his job. From time to time, he would remember the man on the bicycle and wonder what it had all been about. One day, to his surprise, he ran into the man on the street, who himself was now much older. He stopped to chat for a moment, and the subject of the man's frequent border crossings came up. He mentioned that in all those years, they never found anything other than sand, so what was he doing with all those boxes of sand? The man smiled and said, "It wasn't sand I was taking across the border, it was bicycles!"
It makes me smile when I listen to people who think financial institutions make their money in the stock markets, and that personal investors can't. While there is a component which is made up from investment returns, don't be fooled into thinking that is how the professionals make the real money. Financial institutions make their returns from fees and service charges (in good times and in bad). Historically, the stock market has done something around a nine percent average annual return. Very few managers have consistently beat the markets over a long period of time. Ask your financial advisor what return to expect on your investments and they will say five, or six percent.
Do The Math
Are we really expected to think returns of five, or six percent account for the lion's share of financial institutions earnings? Have you ever wondered why so few people know about Exchange Traded Funds, and everybody (almost) knows about Mutual Funds? Might the difference in service charges and loading fees, and management expenses, and commissions explain some of the discrepancy? I'll let you do the math.
The easiest way for personal investors to increase returns is to decrease expenses. Obviously, that would not be in the industry's best interest. I find it interesting how returns receive so much attention, while so little interest is given to explaining expenses.
Could it be that our bicycle riding friend also worked for the financial services industry? It seems they both know how to distract others from seeing what really matters.
Do you still own mutual funds?