A DIY Lesson Learned

Earlier this week, while performing some annual maintenance on my hot water heater in my home, I noticed that water kept dripping from the pressure relief valve after I had tested it. I played with the valves some, looked for ideas on the internet (tap them a few times), I tapped them a few times, then I went about my day hoping that when I checked back later, the drip would have stopped.

The next morning, my wife went outside to retrieve something from her car and came back in with a question. “Have you seen all the water in the driveway,” she asked?

Getting What You Don’t Pay For

Please consider the investment objectives, risks, charges, and expenses carefully before investing in Mutual Funds. The prospectus, which contains this and other information about the investment company, can be obtained directly from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

Does that sound familiar? If you scroll to the bottom of this webpage, you will see this common language encouraging you to read the prospectus of any mutual fund you are considering for purchase. But even if you heed the call to read this legally required disclosure, you probably aren't seeing the whole picture.

For example, did you know that funds also produce another document that discloses how much the fund pays in trading commissions? Those expenses are not included in the fund's expense ratio and are typically expressed as a dollar amount on a financial statement that can be found in the Statement of Additional Information (SAI).

This is just one example of the type of diligence that you, or an advisor on your behalf, should be conducting when considering the inclusion of mutual funds and Exchange Traded Funds(ETFs) in your portfolio. Funds and ETFs are required to produce these disclosures in prescribed formats. Throw in holdings reports, typically produced semi-annually but sometimes more frequently, and you have the information you need to start making informed decisions.

This week I share the July 2017 Issue Brief from DFA titled Getting What You Don't Pay For. It provides a quick insight into why the information found in documents such as prospectuses and SAIs matters. Enjoy the short read and have a great weekend!

Getting What You Don’t Pay For

Costs matter. Whether you’re buying a car or selecting an investment strategy, the costs you expect to pay are likely to be an important factor in making any major financial decision.

People rely on a lot of different information about costs to help inform these decisions. When you buy a car, for example, the sticker price tells you approximately how much you can expect to pay for the car itself. But the sticker price is only one part of the overall cost of owning a car. Other things like sales tax, the cost of insurance, expected routine maintenance costs, and the potential cost of unexpected repairs are also important to understand. Some of these costs are easily observed, and others are more difficult to assess. Similarly, when investing in mutual funds, different variables need to be considered to evaluate how cost‑effective a strategy may be for a particular investor.

Expense Ratios

Many types of costs lower the net return available to investors. One important cost is the expense ratio. Similar to the sticker price of a car, the expense ratio tells you a lot about what you can expect to pay for an investment strategy. Exhibit 1 helps illustrate why expense ratios are important and shows how hefty expense ratios can impact performance.

This data shows that funds with higher average expense ratios had lower rates of outperformance. For the 15-year period through 2016, only 9% of the highest-cost equity funds outperformed their benchmarks. This data indicates that a high expense ratio is often a challenging hurdle for funds to overcome, especially over longer horizons. From the investor’s point of view, an expense ratio of 0.25% vs. 0.75% means savings of $5,000 per year on a $1 million account. As Exhibit 2 helps to illustrate, those dollars can really add up over longer periods.

Exhibit 1.       High Costs Can Reduce Performance, Equity Fund Winners and Losers Based on Expense Ratios (%)

Exhibit 2.       Hypothetical Growth of $1 Million at 6%, Less Expenses

The sample includes funds at the beginning of the 15-year period ending December 31, 2016. Funds are sorted into quartiles within their category based on average expense ratio over the sample period. The chart shows the percentage of winner and loser funds by expense ratio quartile; winners are funds that survived and outperformed their respective Morningstar category benchmark, and losers are funds that either did not survive or did not outperform their respective Morningstar category benchmark. US-domiciled open-end mutual fund data is from Morningstar and Center for Research in Security Prices (CRSP) from the University of Chicago. Equity fund sample includes the Morningstar historical categories: Diversified Emerging Markets, Europe Stock, Foreign Large Blend, Foreign Large Growth, Foreign Large Value, Foreign Small/Mid Blend, Foreign Small/Mid Growth, Foreign Small/Mid Value, Japan Stock, Large Blend, Large Growth, Large Value, Mid-Cap Blend, Mid-Cap Value, Miscellaneous Region, Pacific/Asia ex-Japan Stock, Small Blend, Small Growth, Small Value, and World Stock. For additional information regarding the Morningstar historical categories, please see “The Morningstar Category Classifications” at Index funds and fund-of-funds are excluded from the sample. The return, expense ratio, and turnover for funds with multiple share classes are taken as the asset-weighted average of the individual share class observations. For additional methodology, please refer to Dimensional Fund Advisor’s brochure, The 2017 Mutual Fund Landscape. Past performance is no guarantee of future results.

For illustrative purposes only and not representative of an actual investment. This hypothetical illustration is intended to show the potential impact of higher expense ratios and does not represent any investor’s actual experience. Assumes a starting account balance of $1,000,000 and a 6% compound annual growth rate less expense ratios of 0.25% and 0.75% applied over a 15-year time horizon. Taxes and other potential costs are not reflected. Actual results may vary significantly. Changing the assumptions would result in different outcomes. For example, the savings and difference between the ending account balances would be lower if the starting investment amount was lower.

While the expense ratio is an important piece of information for an investor to evaluate, what matters most when gauging the true cost‑effectiveness of an investment strategy is the “total cost of ownership.” Similar to the car example, total cost of ownership is more holistic than any one figure. It looks at things that are readily observable, like expense ratios, but also at things that are more difficult to assess, like trading costs and tax impact. It is important for investors to be aware of these and other costs and to realize that an expense ratio, while useful, is not an all‑inclusive metric for total cost of ownership.

Trading Costs

For example, while an expense ratio includes the fund’s investment management fee and expenses for fund accounting and shareholder reporting (among other items), it doesn’t include the potentially substantial cost of trading securities within the fund. Overall trading costs are a function of the amount of trading, or turnover, and the cost of each trade. If a manager trades excessively, costs like commissions and the price impact from trading can eat away at returns. Viewed through the lens of our car analogy, this impact is similar to excessively jamming your brakes or accelerating quickly. By regularly demanding immediacy like this when it may not be necessary, the more wear and tear your car is likely to experience and the more fuel you will end up using. These actions can increase your total cost of ownership. Additionally, excessive trading can also lead to negative tax consequences for the fund, which can increase the cost of ownership for investors holding funds in taxable accounts. The best way to try to decrease the impact of trading costs is for funds to avoid trading excessively and pay close attention to effectively minimizing cost per trade. Employing a flexible investment approach that reduces the need for immediacy, thereby enabling opportunistic execution, is one way to potentially help accomplish this goal. Keeping turnover low, remaining flexible, and transacting only when the potential benefits of a trade outweigh the costs can help keep overall trading costs down and help reduce the total cost of ownership.


The total cost of ownership of a mutual fund can be difficult to assess and requires a thorough understanding of costs beyond what an expense ratio can tell investors on its own. A good advisor can help investors look beyond any one cost metric and instead evaluate the total cost of ownership of an investment program—and ultimately help clients decide if a given strategy is right for them.


Source: Dimensional Fund Advisors LP.

There is no guarantee investment strategies will be successful. Diversification does not eliminate the risk of market loss. Mutual fund investment values will fluctuate and shares, when redeemed, may be worth more or less than original cost. The types of fees and expenses will vary based on investment vehicle. Investments are subject to risk including possible loss of principal.

All expressions of opinion are subject to change. This article is distributed for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services.

A Few Miles From Uncertain

When did you start investing? 

My first investment was with my first IRA contribution in 1992. The previous year had been a really good one for stocks and most indicators showed an economy on the rebound from the 1990 recession, but jobs were not being created as quickly as in previous recoveries. Stocks were trading near all-time highs, which made me wonder if I should wait for a better time to buy. Adding to the angst, it was an election year, and the jobs issue made what initially looked like would an easy re-election for the incumbent less certain.

The pace of the recovery was so tepid that a relatively unknown governor from Arkansas was gaining momentum with an entire presidential campaign strategy built around the phrase, “It’s the economy, Stupid”. In addition, a straight talking billionaire was attracting attention for memorable quips such as his description of job losses to Mexico causing a "giant sucking sound". All the while, the President couldn't believe that so many people read lips.

Despite all that doubt, the S&P 500® had a respectable return of 7.6% that year. In fact, with dividends reinvested, the fund I invested in is now worth over four times as much as my initial contribution.

Along the way, there were many uncertainties that tested my risk tolerance. Looking back now, it can seem obvious that taking risks and staying the course was the right decision. However, at the time they occurred, the ever present concerns about bubbles, busts, inflation, deflation, terrorism, war, the economy, etc, tested even the most steadfast investors.

Perhaps I owe some of my resolve to growing up just a few miles from Uncertain. Uncertain, Texas, that is. If you're not familiar, check out this recently released Ewan McNicol documentary titled, "Uncertain". It has absolutely nothing to do with investing, but it will give you some insight into living on troubled waters deep behind the Pine Curtain of East Texas.

Today, the worries in the investing world may be different than in 1992 (or not), but the concept of risk and reward is ever present. This week, I share with you the latest Issue Brief from my friends at Dimensional Funds that explores the paradox of uncertainty.

In addition, I’ve included a short video on dealing with uncertainty from DFA’s founder and Executive Chairman, David Booth.

I hope you enjoy the information. Get in touch if you’re feeling, well, uncertain.

The Uncertainty Paradox

May 2017

"Doubt is not a pleasant condition, but certainty is an absurd one."

“The market hates uncertainty” has been a common enough saying in recent years, but how logical is it? There are many different aspects to uncertainty, some that can be measured and some that cannot. Uncertainty is an unchangeable condition of existence. As individuals, we can feel more or less uncertain, but that is a distinctly human phenomenon. Rather than ebbing and flowing with investor sentiment, uncertainty is an inherent and ever-present part of investing in markets. Any investment that has an expected return above the prevailing “risk-free rate” (think T-Bills for US investors) involves trading off certainty for a potentially increased return.

Consider this concept through the lens of stock vs. bond investments. Stocks have higher expected returns than bonds largely because there is more uncertainty about the future state of the world for equity investors than bond investors. Bonds, for the most part, have fixed coupon payments and a maturity date at which principal is expected to be repaid. Stocks have neither. Bonds also sit higher in a company’s capital structure. In the event a firm goes bust, bondholders get paid before stockholders. So, do investors avoid stocks in favor of bonds as a result of this increased uncertainty? Quite the contrary, many investors end up allocating capital to stocks due to their higher expected return. In the end, many investors are often willing to make the tradeoff of bearing some increased uncertainty for potentially higher returns.


While the statement “the market hates uncertainty” may not be totally logical, it doesn’t mean it lacks educational value. Thinking about what the statement is expressing allows us to gain insight into the mindset of individuals. The statement attempts to personify the market by ascribing the very real nervousness and fear felt by some investors when volatility increases. It is recognition of the fact that when markets go up and down, many investors struggle to separate their emotions from their investments. It ultimately tells us that for many an investor, regardless of whether markets are reaching new highs or declining, changes in market prices can be a source of anxiety. During these periods, it may not feel like a good time to invest. Only with the benefit of hindsight do we feel as if we know whether any time period was a good one to be invested. Unfortunately, while the past may be prologue, the future will forever remain uncertain.


In a recent interview, David Booth was asked about what it means to be a long-term investor:

“People often ask the question, ‘How long do I have to wait for an investment strategy to pay off? How long do I have to wait so I’m confident that stocks will have a higher return than money market funds, or have a positive return?’ And my answer is it’s at least one year longer than you’re willing to give. There is no magic number. Risk is always there.”

Part of being able to stay unemotional during periods when it feels like uncertainty has increased is having an appropriate asset allocation that is in line with an investor’s willingness and ability to bear risk. It also helps to remember that, during what feels like good times and bad, one wouldn’t expect to earn a higher return without taking on some form of risk. While a decline in markets may not feel good, having a portfolio you are comfortable with, understanding that uncertainty is part of investing, and sticking to a plan that is agreed upon in advance and reviewed on a regular basis can help keep investors from reacting emotionally. This may ultimately lead to a better investment experience.



Source: Dimensional Fund Advisors LP.

There is no guarantee investment strategies will be successful. Diversification does not eliminate the risk of market loss.

All expressions of opinion are subject to change. This article is distributed for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services.