You Too Can Save On Management Fees While Going Broke
As the lines between the terms amateur, hobbyist and professional, blur and disappear faster than one can say, “Do it yourself,” prudence demands a moment to take a hard look at this modern mindset. If the urge to build a raised garden in the backyard strikes, by all means do your research, buy supplies and settle in for a long weekend of miniature triumphs and defeats. You might just quit, or maybe you’ll construct a landscape worthy of next month’s Architectural Digest. In all likelihood, the result will fall somewhere in between, and the mission’s final value will lie in the eye of the amateur gardener.
It would be inadvisable, moronic and possibly illegal (depending on chosen anesthetics) for even a surgeon to attempt a repair of their own torn anterior cruciate ligament. There is no amount of money saved, pride in accomplishment, or chance of success that can outweigh the astronomical level of risk and probability of a knee-ruining, life-altering misadventure.
The two aforementioned cases are oversimplified, extreme examples. Garden construction might be fun, but hanging a door by oneself as an amateur carpenter can quickly become a unique way to ruin a Sunday, and while self-surgery is out of the question, saving time and money through sober self-triage is often preferable to a trip to the ER. Plumbing, selecting health insurance, even filing one’s own taxes — just about every facet of our lives now involves some degree of choice when it comes to participation.
A new entry to this trend of DIY fetishism is the decision on how your money is managed and who manages it. Not long ago, the decision for most people was limited to choosing a person, or firm, to undertake this task for them. Of course, that decision wasn’t always easy and even after this selection there were typically a few brief, but important questions that aimed to steer the overall plan in accordance with the client’s aims and risk tolerance. Other than the bank transactions and requisite signatures, that was often it for client participation.
Over the past two decades, an explosion of discount brokerage services combined with widespread internet accessibility has shifted the way financial institutions conduct business and have opened the door for the non-professional to play a larger role in investing their own money. Judging by some of the commercials that advertise trading on these platforms, one would be a fool not to be actively trading their own money! A viewer watches the blissfully couple, with confident auras and big smiles, casually walking through a complex sea of high-tech figures and graphics, eventually ending up on a beach at sunset. There are some important if not obvious caveats to remember before being taken in by this theatre: these are paid actors and not real stories, the company’s main goal is to make money by having you use their platform, regardless of your outcome, and no, trading your own money profitably is not that easy. Sure, you can start trading today with no minimum balance and low-commission trades, but should you? Just because you can do something doesn’t mean that you should , and in all but the most egregious instances, the amount that you can save on brokerage and management fees is probably one of the least important factors in choosing a financial roadmap.
At the end of the day, or in this case one’s career, the goal of investing is to have at least enough funds to retire comfortably. Once that objective can be reasonably assured, then the next aim would be to maximize the amount of one’s investments and perhaps spend some time on the beach with the folks from the comically scripted commercial. In the real world, how does one get there? We can look at three generalized routes: personal selection of financial instruments (stocks, bonds, futures, etc.), diversified investment vehicles (index funds, ETFs, etc.), and actively managed funds where managers attempt to beat the market by picking and choosing investments and actively trading other financial products. In reality, there are many subcategories to each of these methods and many investors will involve a varied mix of all three.
With the increase of low brokerage, online trading platforms, there has been a corresponding rise in criticism of actively traded funds, much of it centering around the annual fees deducted for management. “Why pay a firm money to do things that you can do yourself?” seems to be the underlying logic of the critique. Perhaps a better question is, “Would you be upset if you paid someone a bit of money, if it made you more money than you would have on your own?” If your answer to this question is yes, then I would advise you to stop reading. No matter how you invest, or how much the investments succeed or fail, you are likely the type that will spend their retirement on a beach, only to ruminate about how much more you could have had . This is exactly the emotional nerve that online brokers intend to pluck when touting their low-rates. As an American, the ultimate insult is to have someone cheating you out of your hard earned cash. The fact that they aren’t really cheating you out of anything, but providing you an incredible service for a very fair price is something that used to be considered good business. It still is.
For the sake of the exercise, let’s assume that these actively traded funds actually have been taking advantage of their hapless customers. Luckily, the advent of index funds, ETFs (exchange traded funds), and other passively managed funds have come to the rescue of the pedestrian investor who is too smart to be ripped off by the old brick and mortar firms. These vehicles are numerous and varied, and even a few can reflect bearish sentiment on the market through ownership. However, most of them share two common traits, they are very diversified and almost always bullish. They place investors in a position to capitalize on the growth of certain industries, or the economy as a whole, all while saving money on management fees.
There is plenty of wisdom in this approach to investing. Even a reasonable manager fee-range of 55 to 85 basis points, when sacrificed and compounded annually, can result in significant reductions in long-term profit. An e-mini (the most actively traded S&P 500 index contract) purchased for $2,028.18 on January 1, 2015 was worth $3,278.20 on January 1, 2020. It’s hard to argue with 10.1% year over year growth, and it’s better than most returns on actively traded funds. But, if you bought that same e-mini on the first of this year and evaluated its year to date performance on July 1st, you’d find it somewhat less impressive-down 4.1%. The Dow Jones Industrial index has been even more anemic over the first half of the year, losing 9.3% of its value in that time frame. Of course, this is due to the current pandemic, but it bears mentioning that Morningstar’s Hare Fund had managed to wring out a 1.8% rise through active trading of their stock portfolio by professionals. It seems that there are some advantages to an actively managed fund, and this shouldn’t come as a surprise. It’s easy to garner returns on the way up simply by being diversified, but on the way down it’s a different story.
I personally know of an independent trader that has weathered most of the recent storm and whose account was up 7.0% this year-a feat accomplished through extensive use of options trading. Surely there are countless other individuals and firms that have made even more money in 2020. Why limit yourself to passive funds that lose money under bearish circumstances, or curtail your gains by paying management fees? It seems that the only way to avoid those outcomes would be to personally trade, or invest, your own account. So, the online brokers are right. Right?
Yes, if you want your portfolio to perform better in a weakening market and also save money on management expenses, investing for yourself is the only way to go.
But also no, in that discount brokerage firms don’t mention that it is a losing proposition for the vast, vast majority of people. The difficulty rating on the “do it yourself spectrum” is high. It is a task which lies much closer to successful self-surgery than amateur gardening. Why is that? The reason is simple. You will be competing against the aforementioned managers, firms and traders who do this professionally, for a living. One can safely bet that the pros have better and more up to date information to decide which stocks are undervalued, which companies might be facing legal issues, and which industries are on the decline. If an amateur decides to dip their toes into actively trading more esoteric instruments like derivatives or futures, they will have to match wit and nerve with the best players in a worldwide arena. Did I mention that their algorithms will be more precise, their software more robust, their hardware light years faster, and their pockets endlessly deeper?
All of that might be surmountable, but the time commitment will not be. Much of the competition will not only be putting in their weekly dues, but they will be checking markets after hours, reading articles, and having casual conversations about financial topics-for fun. For some managers and traders, it is not just a profession. It is a passion. It gets them up in the morning. It is their life.
To compete with the pros you have to be a pro. Make no mistake, it is a competition. Unlike creating and tending a backyard garden, there is no intrinsic reward for investing or trading at a sub-par level. People are unlikely to look back on poor returns and find solace in knowing that “they did it themselves.” At least I have yet to hear it. These are just scenarios that are “slightly less good.” Any risk manager for an online brokerage has story after story of customer accounts that they have had to liquidate or close after they went belly-up. You can call a plumber after a failed experiment in amateur sink repair. I’m not sure who you call after losing part or all of your retirement nest.
Sure, there are some people who will have an innate knack for the craft and there are others who will catch a few breaks and get lucky. Most will struggle, stress, and fight to keep within punching distance of professionally managed portfolios and passive index funds. If all of this still sounds appetizing to you, then you might want to consider a career change and enter the world of professional finance. But the next time the slick man from the TV commercial, or pop-up ad starts trying to sell you on online trading, hit the mute button and remember what he’s really saying, “You Too Can Save On Management Fees While Going Broke!”
Originally published at https://williewitten.com.