Why Pay Fees To Managers? Use Index Funds

If you are unhappy with fees charged by active money managers, stop paying them. Low-cost index funds track the stock market, say Mitch Tuchman and Charley Ellis at Rebalance.

“There hasn’t been a five-year period in over six decades when a 50-50 stock-and-bond portfolio has not shown a positive return,” said Tuchman, of Palo Alto, Calif. “If you own markets through indexing, your portfolio always recovers in a correction. There is a way to really win at this game – by playing not to lose.”

Hometown firm Vanguard’s exchange-traded fund (VOO) charges as little as a 0.05 percent management fee – and tracks the S&P 500. Only 3 percent of all active managers outperform the stock market, Ellis said.

“You have to be an exceeding talent, like Roger Federer. You have to be that good to be better” than the index, Ellis added.

Low-cost means about 0.25 percent in fees – not 1 percent. The impact of “only 1 percent” accumulates over time. For example, two investors each start with $100,000 and add $14,000 each year for 25 years. One manager charges 1.25 percent, whereas the other charges 0.25 percent – a difference of “only 1 percent.”

After 25 years, both investors have more than $1 million, but the difference between them is $255,423: More than a quarter-million dollars separate $1,400,666 from $1,145,243. This financial scenario was provided by Ellis.

Nicolas Rousselet, head of hedge funds at Unigestion, said nine out of 10 managers were overpaid. Ellis agrees the fees are “hard to justify.”

“I invested [in hedge funds] in the past, but not currently. I wised up,” said Ellis. “I believe in the imperfection of human beings. I make mistakes. They apply to me, even though I’ve been investing for decades. For me, reducing the number of mistakes [by indexing] makes a lot of sense.”

Rebalance is using iShares, Schwab, and Vanguard funds, such as Vanguard Intermediate-Term Corporate Bond ETF (symbol: VCIT) iShares iBoxx $ High Yield Corporate Bond ETF (HYG), and iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB).

Rebalance also uses Vanguard High Dividend Yield ETF (VYM), Schwab Total Market Index Fund (SWTSX), Vanguard FTSE Emerging Markets ETF (VWO), Vanguard FTSE Developed Markets ETF (VEA), and iShares Core S&P Small-Cap ETF (IJR), and Vanguard FTSE All World ex-US Small-Cap ETF (VSS).

Full disclosure: Ellis at one time was on the board of directors at Vanguard.