Are Investment Fees Secretly Draining Your Wealth? Find Out Now!

Do you know what you're paying in investment fees and expenses? You probably know what you're paying for your latest streaming media service, Hulu or Netflix. However, do you know your investment fees and expenses? Because they could be costing you tens of thousands, if not hundreds of thousands of dollars. Hey, I'm Casey Weade, CEO and founder here at Howard Bailey Financial, and I'm also a certified financial planner practitioner.

And we're here to talk about investment fees and expenses. I have yet to see anyone walk into my office and sit down in front of me and be able to tell me exactly what they're paying in fees and expenses. We always have to do an analysis.

It's very important that you always know what your net is at the end of the day. It's not all about the gross. It's about how much you actually get to keep.

I'm going to be walking you through an analysis of a portfolio of funds that we analyze for someone that visited with us. And when we take a look at this, you're going to see all the different expenses that are actually in those mutual funds. Then we're going to talk about evolving those into ETFs.

What was the impact of that? And then we're going to take it a step further with something called direct indexing, where we can aim to take those fees and expenses even lower and keep more of your hard-earned money where it belongs in your pocket. So first, we're using a tool here where we're analyzing actual mutual funds in this $1.5 million portfolio. And we're going to find they're spending about $25,000 a year in expenses just inside the mutual funds.

This is something that I find so many do-it-yourselfers and those with advisors are really unaware of, is just how much those mutual funds are actually costing them. And many times we'll find even a do-it-yourselfer who didn't want to pay an advisory fee might be able to spend actually less and get a partner in creating that financial plan and managing those investments by exiting some of these mutual funds, lowering those internal costs, and even potentially adding an advisory fee can at least help them break even and have a better plan along the way. When we look at this portfolio, there's 14 different mutual funds that this $1.5 million portfolio has inside of it.

And there's also a lot of overlap here. We're going to see that they have, for instance, two international large cap growth funds. There's not always a lot of necessity to create that much excess diversification because we can create more diversification than actually helps us.

And it also adds fees and expenses, and of course, complexity along the way. This $1.5 million portfolio has a bottom line cost of $22,739. But I'm going to take a look at each one of these and walk you through what those expenses are.

So first, let's take a look at this Invesco Diversified Dividend Fund. And this is about $120,000 of their $1.5 million portfolio. And its expense ratio is what's advertised.

So their advertised expenses are 0.57% per year. However, they don't have to legally disclose all of those expenses because there's additional expenses in there that they can't necessarily predict. For instance, how often are they going to trade this year? They don't know how many times they're going to trade this year.

So it's difficult, they say, for them to factor those expenses in to that expense ratio. But we can use our software, look backwards, and it can give us a good estimate of what those costs actually have been and what they might be in the future. And that comes down to something called turnover.

So turnover inside this fund is 39%. That means if they started the beginning of the year with 100 holdings, they swapped out 39 of those holdings by the end of the year. 39% of the portfolio was turned over.

And every time there's something bought and sold inside of a mutual fund, there's a cost to that. There's a transaction cost to that. And that transaction cost is also something they're saying, well, we can't predict what that's going to be, but we can estimate what that cost is.

And that 39% turnover is costing them about $220 in trading costs. We have the expense ratio, about $700 a year. And then there's this thing called tax cost.

That actually ends up being their biggest expense. Now, this is a taxable account. So if it was in a tax-deferred account, if you had a tax-free account, so if you held this fund in a Roth IRA, traditional IRA, your 401k, then you wouldn't have to worry about that tax cost because it's all tax-deferred.

However, this is in a taxable account. So we're also assuming that this couple is in a 20% ordinary income tax rate, and they're also in a 15% long-term capital gains tax rate. So with those things combined, the level of turnover in this fund is costing them $1,500 per year for a total cost of $2,400 per year.

That's a little over 2% per year that that fund is actually costing them. Let's take a deeper dive and compare it to some alternatives. So our software will give us some alternative funds that would be lower cost in that same category of fund.

And we're going to find they're all ETFs. This is the evolution of management. It was mutual funds, mutual funds came along, then ETFs came along, and we're going to find here in a little bit, something called direct indexing has now come along in the last several years, and it's dramatically growing in popularity, much like ETFs did.

But if we look at the ETF alternatives here, we could go from a $2,400 a year cost to a $524 a year cost with this Vanguard fund. And we end up with last year's actual returns for these two funds. We can see we're adding a pretty substantial return to this fund by swapping it out with a new one.

And we're also dramatically reducing those expenses that we're paying. And one of the things that Morningstar Research has shown us is that the number one determinant of your long-term performance is going to be all about expenses. So it's very important that we emphasize those expenses and try to minimize them as much as we possibly can.

So what we did was we went through, we analyzed each one of those individual mutual funds and replaced them with a lower cost ETF alternative to create the same basic makeup of funds and asset allocation mix across stocks and bonds, both domestically and internationally. And what we ended up creating was first, we look back at the old one, $22,739 per year in total cost, 1.53%. That doesn't include any advisory fees. I want to emphasize that as well, because this person was actually paying an advisory fee on top of that 1.53%. And of course, we would charge a fee on top of whatever internal expenses we might have if we're working on a financial planning basis with a family or with yourself.

But this is a good starting point. We want to know what the internal expenses are. So 1.53% a year, $22,739 per year is what just the mutual fund costs are.

Now, if they were paying 1% a year on top of that 1.53%, obviously it's 2.53% a year, that's $37,000 a year. We've been able to work with people in the past where we've been able to lower their cost enough that that's about how much income that they actually need on an annual basis from the portfolio. It makes a big difference.

So we wanted to replicate this. If we replicate this in ETFs, now that internal cost goes down to $7,500 a year, 0.51%. 51 basis points or a half a percent per year. So we went from one and a half percent a year to a half a percent a year.

And we kept our same basic mix of U.S. stocks and international equities. We can see that was about 70% U.S., 30% international. And when we look at the previous holdings, we saw that that was pretty close to the same.

So we had about 70-30 mix, 70% U.S., 30% international. They had some slight sprinkles in there of 1%, 2% and fixed income and a little alternative. But for the most part, we replicated what they had before with index funds or ETFs quite specifically.

But we can also take this a step further. And this is what I'm talking about, this evolution of money management. And I think this is really interesting.

We hear retirees all the time talking and complaining about inflation, rightfully so. If we go back 20 years ago, a gallon of milk was about $3. Now it's over $4.

But what's interesting in the investment advisory world, the mutual fund world, the investment world as a whole, those expenses are going the opposite direction. Due to competitiveness and technology, we're seeing actually deflation in your cost of investing. But if you're still investing the same way that you were 20, 25, 30 years ago today, then you're missing out on some of those deflationary pressures that you could be benefiting from, which is, you could argue, a bit of an inflation hedge as well.

So now let's talk about direct indexing. What is it? How does it work? And we have some great resources here from Fidelity and Morningstar that I want to take a look at to help to explain it. We have this great graphic from Fidelity.

This graphic from Fidelity shows us really how this process of direct indexing works. So this is what the S&P 500 would look like. We have 11 different industries that represent that S&P 500 and 500 individual stocks.

In order to replicate what the S&P 500 is doing and track that index, nobody's going to go out, for the most part, unless you have tens of millions of dollars, you're not going to buy all 500 individual stocks. You're probably buying it in an ETF. You're probably buying it in an index mutual fund for that matter.

However, today we can replicate that with direct indexing, and that involves buying individual stocks from an index in the proportion needed, just the proportion needed across those industries in order to replicate the performance of the S&P 500 as a whole. And there's a lot of benefits to doing that. Morningstar had a great article that they put out and a good graphic that went along with it to talk about the differences between mutual fund index funds, ETF index funds, and direct indexing.

Now, all three of these tools are tracking an index, the S&P 500. Maybe it's tracking the NASDAQ for that matter. Maybe it's tracking mid caps or small caps, an all-cap approach.

It could track a variety of different indexes. You actually own those underlying securities. In an ETF and a mutual fund, you lose control over your taxation because you don't actually own any of those individual stocks inside the fund.

You own the fund itself. And so every time something's bought and sold, you lost control over that, and you're ending up getting taxed for those things. With direct indexing, you own those individual positions.

Portfolio personalization is allowed inside of a direct index. If you said, I don't want to own Philip Morris, or you want to do some type of environmental, social, maybe governance type of picking, and you want to pull out certain holdings that you wouldn't want in your S&P 500 replication, then you can do that. Obviously, when you start messing with the direct index, it's not necessarily going to track that index perfectly as well as it would if you didn't pull some of those holdings out.

But you do get that benefit of personalization, most of all. I think this is the biggest benefit outside of cost when it comes to direct indexing. That's tax loss harvesting.

And that is something that allows us to create what's called tax alpha. Now that you own these individual positions, maybe you own 40 to 50 individual positions inside of your S&P 500 replication. And there's going to have to be some trading that happens throughout the years.

We have some volatility in those individual positions. Those things have to be swapped out. And there's going to be opportunities for us to sell something at a loss, generate a loss, and swap that out for a different position.

If you just own the ETF, you couldn't sell that one position that's down in value to generate a loss and replace it with something else. So in doing so, you might be able to create a half a percent, one percent a year in tax savings, which as I said, it's all about the net. So it's essentially return that you're putting back in your pocket by doing active tax loss harvesting.

And you have a lot more flexibility in doing so because you own the individual stocks versus owning those in an ETF. However, the downside is we're in an index mutual fund or an index ETF, you have pretty low minimums. I mean, for a couple of hundred bucks, you can get yourself into an ETF.

But when it comes to direct indexing, those minimums are higher. Now you'll read sometimes those minimums are $250,000, a half a million, a million dollars. The reality is those minimums for an individual direct index replication strategy is probably much lower than that, maybe $25,000, $50,000.

However, you can imagine if you want to replicate a portfolio that creates true diversification, then you might need to have three, four or five different direct index strategies. And so that may be that you need $250,000 or a half a million dollars in order to create a true diversified strategy, leveraging direct indexing and get all of the benefits of direct indexing itself. I want to show you what our kind of replication looks like of the S&P 500.

So these are the holdings that you would find in our S&P 500 strategy as of the date that we're recording this. And that's going to change, as I said, over time. There's a $50,000 minimum.

There's typically 40 to 50 different holdings. And these holdings are going to change throughout time. We're going to sell those that might be at a loss, maybe replace it with another position that's in the same industry.

And at the end of the day, we want to track the index. How accurate is it? That's the next strategy. That's the next thing that you want to ask yourself.

How good is it at tracking the S&P 500? Well, what we're seeing here is it's pretty darn close. This green line is the strategic index S&P 500 replication strategy we use, whereas this gray line is the S&P 500 benchmark. And we can see it tracks it pretty darn close.

And it's doing so without owning the exact amount of holdings in each one of those different sectors. We might be overweighted, consumer cyclicals, and we might be underweighted, basic materials. But at the end of the day, we're still able to track that index and get you a lot of benefits.

And as we talked a lot about the tax benefits, let's see what those cost benefits are. So when it comes to those cost benefits, we saw that we were paying about 1.5% in internal expenses with the mutual funds, about 0.5% per year with the ETFs. Then we can take a look at what it's costing us to replicate these positions inside of a direct indexing strategy.

Now, we still included a couple ETFs. We wanted to get that international exposure that we had. So we had a small amount still allocated to ETFs.

But by incorporating those direct index strategies, now we're at 1.1% roughly in costs. So we went from 1.5% to about 0.5% to about 1.1%. And of course, as I said, this doesn't include an advisory fee. But you can easily see how by including an advisory fee, but going with these lower cost strategies, you might be able to pick yourself up a financial planner that's going to be there as a partner for you.

That's going to help you with tax planning, income planning, and investment planning, healthcare planning, estate planning, help you look at that big picture. Might not even cost you any more or even save you some money over what you're paying today. So what I'm offering you today is an opportunity to crack that portfolio open, see if you have any money that might be falling through the cracks.

In order to get your free fee analysis, all you have to do is call the number on your screen and schedule a time to visit with one of our fiduciary financial planners.