Tom Sedoric

If one is candid with one’s clients, then managing expectations is a vital part of one’s job - especially in challenging and uncertain economic times such as these. 

Such a conservative approach flies in the face of current talking head chatter on the financial channels, where high returns seem as plentiful as good weather in Hawaii. But there is a difference between talking about hypotheticals and actually dealing with the nuts and bolts of retirement investment reality. 

Expectations management is about the frank, ongoing assessment of aligning client goals and levels of risk with the market’s realities. When we recommend lowering expectations, we aren’t pessimistic, just realistic. Global economic growth is slowing, and will likely continue to do so for the next 10 or 15 years. We engage in a higher standard of reality, and not one confined by bullish or bearish labels. 

When we advise our clients that lower returns are possible, we consider a number of factors. The risk for some factors is glaringly apparent. For example, we continue to wonder whether central bank economic policies – to prop up their economies with monetary policy – will prove merely a Potemkin illusion of stability. The near-zero return on government bonds and cash and the recent phenomenon of insurance companies seeking to buy out current insurance contracts suggests that even the big money recognize that lower returns are on the horizon. Insurance carriers had likely counted on much higher interest rates in their actuarial calculations. We also believe that a balanced portfolio will lead to lower returns in the current economic climate. 

What else can be done to maximize returns and add to the retirement nest egg and income stream? Saving more is always the easiest and smartest option, yet few seem willing or are not able to do so. Another strategy is to increase awareness about tax efficiency and asset location, not just allocation. We expect that our clients would tell you that we beat this drum with numbing regularity as we continually see the same scenario play out: people who do not What else can be done to maximize returns and add to the retirement nest egg and income stream? Saving more is always the easiest and smartest option, yet few seem willing or are not able to do so. Another strategy is to increase awareness about tax efficiency and asset location, not just allocation. We expect that our clients would tell you that we beat this drum with numbing regularity as we continually see the same scenario play out: people who do not.

Additionally, for the past three to five years, we have also taken a critical look at asset management expenses. We know this isn’t the most exciting of initiatives (though it does get some traction in the 401k world) but as fiduciaries, we work hard to keep internal costs very low. The math is simple: every dollar saved on asset management fees, coupled with good gamma, adds to an investor’s total return. 

Most people understand there are some fees associated with mutual fund investing. As a primer, the funds charge annual expenses to cover the fund’s operating costs including management fees, distribution, and service fees – also known as 12b-1 fees – and general administrative expenses. These expenses are deducted from the fund before its returns are calculated. Investors may not know the range can be as much 2.6 percent or higher or as low as 1 percent or less. 

A recent Morningstar study revealed some intriguing facts about mutual fund expenses. In the broad U.S. equity group, funds with expense ratios in the lowest quintile had a 55.98 percent success rate from 2008 to 2013. The study determined the next-cheapest tier of funds had a success rate of 45.69 percent while funds with average expenses had a 38.84 percent success rate. And here is an eye-opening finding: the most-expensive quintile of funds had a success rate of just 23.57 percent. In other words, the higher the fees, the less likely funds were to survive and outperform. The results were across-the-board similar in the sector-equity, internationalequity, taxable-bond, and municipal-bond groups. 

Most investors, and especially retail investors, don’t realize they have a voice about controlling fees. Investors and their advisors must be informed on differing fee structures, and seek the best combination of gamma and expense. After more than three years of negotiations, we were able to cut expense costs by 30 percent with one of the largest investment vehicles utilized by our practice. We did not advertise this savings to our clients, but many noted the conversion earlier this year as we continue to advocate savings on their behalf. In an environment where investment returns may moderate, tax and expense management will continue to differentiate. 

In a recent column in the New York Times, financial planner Carl Richards was puzzled by the number of investors who chose to pay higher fees in the alternative fund market for no seemingly rational reason. “This behavior isn’t normal,” Richards wrote. “So why is it happening? It might come from sheer boredom with dull, but effective investments like index funds. Maybe we think we need something to help us feel more excited about our portfolios.”

There’s something to be said for preferring the boredom of minimizing expense and maximizing the real, after tax, returns. In our practice, that qualifies as exciting.

 

1 Morningstar: Alpha, Beta, and Now…Gamma. David Blanchett & Paul Kaplan, August 2013 2 Vanguard: The Added Value of Financial Advisors. September 2013

This information has been obtained from sources deemed to be reliable but its accuracy and completeness cannot be guaranteed. The views expressed are those of Tom Sedoric – Partner, Executive Managing Director and Wealth Manager and are not necessarily those of Raymond James.