Mutual Funds vs ETF Expenses
April 4, 2024 | Sage Capone
Key Points for Hawaii Investors
- Mutual Fund Conversion with a Hawaii Financial Advisor can enhance portfolio performance
Mutual Fund Expense Ratios
As fiduciaries to our clients, we are obligated to use the most cost-efficient share class when using mutual funds in client portfolios. Ideally, the most cost-efficient expense ratio for a mutual fund should be on average 0.25% or lower. The focus on using lower-cost share classes stems from the understanding that higher fees can erode investment returns over time.
When helping a new client, the client may transfer an account that currently holds mutual funds with a higher expense share class. While it is acceptable for some clients to keep these mutual funds as part of a custom client portfolio, we do have a fiduciary obligation to convert these shares to a lower-cost option, if available. Mutual fund share classes can be converted (for example, an A share to an I share) at no cost or tax consequence to the client while providing reduced costs and improved overall returns.
The Investment Company Institute (ICI) is the leading association representing regulated investment funds that provides a detailed analysis of the average expense ratios between equity and bond funds. Their research has found that over the past 27 years, expense ratios have dropped by 60% for equity mutual funds and 56% for bond mutual funds. In some cases, a client has Class A (up-front sales charge), Class B and/or Class C (internal fee). These load mutual funds add an additional expense (commission) to investors that reduce their overall return. That is why it is crucial to look at cost-effective alternatives like exchange-traded funds, which an advisor can assist with.
Source:
The Investment Company Institute, Lipper and Morningstar
Figure 3, provided by the ICI research, shows the cost of actively managed mutual funds. The question that most investors ask is: “is the additional cost providing me with better performance?” According to S&P Global, Active Fund Managers have underperformed the S&P 500 benchmarks by a large percentage (see exhibit 1 and 2 below). The underperformance by active mutual fund managers has shown how difficult it can be to time the market with stock picking. The unwelcome tax consequences from short-term trading activity can also diminish the tax benefits of long-term capital gain tax rates for investors.
Mutual Fund Conversion to lower-cost shares is necessary for the following reasons:
- Cost Savings for Clients: Lower-cost shares typically have reduced expense ratios and fees, leading to cost savings for clients. By converting to lower-cost shares, advisors can help clients retain more of their investment returns over time, which can significantly impact long-term wealth accumulation.
- Fiduciary Responsibility: Advisors have a fiduciary duty to act in the best interests of their clients. Choosing lower-cost shares demonstrates a commitment to fulfilling this obligation by seeking out investment options that minimize expenses and maximize returns for clients.
- Performance Enhancement: Lower costs can contribute to improved net returns for investors. With expenses eating into investment gains, reducing costs through lower-cost shares can potentially enhance overall portfolio performance, especially over the long term.
- Regulatory Compliance: Regulatory bodies increasingly emphasize the importance of fee transparency and acting in the best interests of clients. Converting to lower-cost shares aligns with regulatory requirements and helps advisors demonstrate their commitment to compliance and client-centric practices.
Source:
Matt Lovett, Brookstone Capital Management
The Exchange-traded fund (ETF) provides clients with substantial cost savings as you can see in Figure 7 below by the Investment Company Institute. The asset weighted average expense ratio for a passive index fund is 0.15% for bond ETF and 0.11% for an equity ETF.
As always, please do not hesitate to contact Sage Financial Investments for a Free Strategy Review or Second Opinion to discuss your portfolio or re-visit your risk profile.
* Registered Investment Advisor Representatives act as fiduciaries for all our investment management clients. We have an obligation to act in the best interests of our clients and to make full disclosure of any conflicts of interest, if any exist. Please refer to our firm brochure, the ADV 2A item 4, for additional information. Investment advisory services offered through Brookstone Capital Management, LLC (BCM), a registered investment advisor. Investments and/or investment strategies involve risk including the possible loss of principal. For a complete description of investment risks, fees and services, review the Brookstone Capital Management firm brochure (ADV Part 2A) which is available from your Investment Advisor Representative or by contacting Brookstone Capital Management.