Denton County Living Well Magazine Summer 2015 | Page 30
Control
What You Can:
Keep Your
Costs Down
By Richard Ferri, CFA
Y
ou can’t control the markets, but you can control
how much it costs to invest in them. Mutual fund
costs are often couched in terms of expense ratios and commission charges, aka structural costs.
Behavioral costs and tax costs are not as obvious and are
often difficult to quantify. It’s wise to know all the costs, so
you can prevent them from eating away too much of your
return.
sive because there’s no simple way to quantify how badly
someone’s behavior is hurting his or her return. Yet, bad
behavior is often the most expensive cost.
The Cost Triangle: The Investment Cost Triangle combines structural, behavioral, and tax costs together to illustrate the total costs to which we are all exposed. No one
is immune from them, but you can (and should) minimize
your exposure.
Structural costs have a direct impact on investment performance: When your structural costs go down, your expected
return goes up. Many studies have been published over the
years that link an investment’s return to its structural costs.
Overwhelmingly, a negative correlation exists between cost
and return: The higher the structural cost to invest, the lower
the average fund return, and vice versa.
The Investment
Cost Triangle
Source: The author’s forthcoming book,
“The Education of an Index Investor”
Structural costs are easy to
quantify because providers are required by law to
disclose their fund fees and
commissions. Tax costs are
more difficult in that they have to be extracted from your
individual tax returns. Behavioral costs are the most elu28
DENTON COUNTY Living Well Magazine | SUMMER 2015
Structural Cost: Securities law requires that fund companies disclose the fees they impose. These costs include
management fees, administrative costs, distribution fees,
commissions, redemption fees, and more.
Since most market-tracking index funds and exchange-traded funds (ETFs) are in the low-expense category, they have
generated higher historical returns than higher-cost funds in
comparable investment classes.
Behavioral Cost: Advertised fund returns are based on a
formula that compares the performance of one mutual fund
to another after factoring out all deposits and withdrawals
from the funds. This is the fund’s advertised performance.
A different picture emerges when the performance is based
on what investors actually do. This investor return lets us
compare the timing of fund purchases and sales (investor