2857: Why Does Anyone Invest In Expensive Funds? by Kevin Ha of Financial Panther on Index Fund Investing

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[00:00:39] [SPEAKER_00]: This is Optimal Finance Daily. Why Does Anyone Invest In Expensive Funds by Kevin Ha of

[00:00:47] [SPEAKER_00]: FinancialPanther.com. And I'm your host and personal finance enthusiast, Diana Merriam.

[00:00:53] [SPEAKER_00]: Welcome back to Optimal Finance Daily, where I'm here with you each and every day reading from some

[00:00:59] [SPEAKER_00]: of the world's best personal finance blogs. So with that, let's get right to today's article

[00:01:04] [SPEAKER_00]: as we optimize your life. Why Does Anyone Invest In Expensive Funds by Kevin Ha of FinancialPanther.com.

[00:01:17] [SPEAKER_00]: One of the things I've always wondered is why anyone would invest in expensive mutual funds.

[00:01:24] [SPEAKER_00]: I typically define an expensive fund as one with an expense ratio of around 1% or more.

[00:01:31] [SPEAKER_00]: Since there are many mutual funds with expense ratios of 0.1% or less, it's never made much

[00:01:39] [SPEAKER_00]: sense to me why anyone would invest in anything else. Why pay 10 times more to invest your money

[00:01:46] [SPEAKER_00]: in what amounts to basically the same thing? One problem I have is that as someone who's

[00:01:52] [SPEAKER_00]: really into personal finance, I fall into a sort of personal finance bubble. I take a lot of the

[00:01:59] [SPEAKER_00]: stuff I know for granted and assume that everyone just knows this stuff too. In reality, the vast

[00:02:05] [SPEAKER_00]: majority of people have no idea what anything I said even means. I was reminded of this fact

[00:02:12] [SPEAKER_00]: recently when I was talking to my brother about what he's investing his money in. It turns out

[00:02:18] [SPEAKER_00]: that he was entirely invested in funds with a big-name financial services company, all with

[00:02:24] [SPEAKER_00]: expense ratios of at least 1%. After a little bit more digging, I discovered that he gave his money

[00:02:31] [SPEAKER_00]: to a guy he knows at this big-name financial company, who then put the money to work for him.

[00:02:37] [SPEAKER_00]: As my brother explained to me, he went to the guy, gave him his money, and said,

[00:02:42] [SPEAKER_00]: Make it grow. My brother's a smart guy. He's always been good at earning and saving money,

[00:02:48] [SPEAKER_00]: but when it comes to investing, he's not particularly knowledgeable.

[00:02:53] [SPEAKER_00]: All of the basic terms that personal finance people talk about, expense ratios, 401ks,

[00:02:59] [SPEAKER_00]: asset allocation, etc., are gibberish to him, and he has absolutely zero interest in learning

[00:03:06] [SPEAKER_00]: about any of that stuff. Needless to say, I wasn't too happy with his investment choices.

[00:03:12] [SPEAKER_00]: Financial panthers don't invest in expensive funds like that. But my brother's situation

[00:03:18] [SPEAKER_00]: showed me exactly why people still invest in these types of funds.

[00:03:23] [SPEAKER_00]: The reason people invest in expensive funds

[00:03:27] [SPEAKER_00]: Ultimately, the reason people like my brother still invest in these expensive funds,

[00:03:32] [SPEAKER_00]: instead of opting for cheaper alternatives, stems from a lack of knowledge. It basically boils down

[00:03:39] [SPEAKER_00]: to four reasons why someone invests in these, essentially, rip-off funds.

[00:03:45] [SPEAKER_00]: 1. Someone told you to invest that way

[00:03:49] [SPEAKER_00]: There's nothing wrong with getting expert advice, especially in areas where you're not all that

[00:03:54] [SPEAKER_00]: knowledgeable. At the same time though, you really need to take the time to scrutinize where your

[00:03:59] [SPEAKER_00]: advice is coming from. Not everyone has your best interests at heart. I don't know enough about why

[00:04:05] [SPEAKER_00]: my brother's guy put him in the particular funds he's invested in. The only thing I do know is

[00:04:11] [SPEAKER_00]: that they don't seem to be particularly smart investment choices. My guess is that there's

[00:04:17] [SPEAKER_00]: a commission or something else involved. It's the only explanation I can think of for why

[00:04:22] [SPEAKER_00]: a professional would pick funds like these. 2. Picking funds based on brand name

[00:04:30] [SPEAKER_00]: Going with brand names when it comes to investing isn't necessarily a bad thing, mind you.

[00:04:35] [SPEAKER_00]: Vanguard, for example, is a brand name I trust and if I knew absolutely nothing about your investment

[00:04:41] [SPEAKER_00]: choices, I'd say you can't go wrong picking something from Vanguard. At the same time,

[00:04:47] [SPEAKER_00]: I've always seen funds in my employer-sponsored plans that seem way more expensive compared to

[00:04:53] [SPEAKER_00]: the other options. I never understood why anyone would invest in those funds, but my guess is that

[00:04:59] [SPEAKER_00]: people see the brand name and just decide it must be good. 3. Thinking administrative fees are the

[00:05:07] [SPEAKER_00]: only fees you pay One thing my brother told me to justify his investment choices was his belief that

[00:05:14] [SPEAKER_00]: his investments were cheap. When I told him they were way too expensive, he explained to me that

[00:05:20] [SPEAKER_00]: he only paid $7 per year in order to invest. Setting aside the fact that I don't think that

[00:05:27] [SPEAKER_00]: number is accurate either, it's not uncommon for people to think they're paying very little

[00:05:32] [SPEAKER_00]: or even nothing in fees. But everything you invest in has to have some internal costs.

[00:05:39] [SPEAKER_00]: Most people don't even realize that their 401k plan isn't free. In this case, my brother sat

[00:05:45] [SPEAKER_00]: in these funds because he didn't realize that his investment choices carried internal fees

[00:05:50] [SPEAKER_00]: much higher than other alternatives. 4. Thinking they can beat the market

[00:05:57] [SPEAKER_00]: I know most of us personal finance dorks know that the vast majority of funds will not outperform

[00:06:03] [SPEAKER_00]: the market. Still, there are a shockingly high number of people who think that consistently

[00:06:09] [SPEAKER_00]: beating the market is possible, as if we can all be Warren Buffett. Do yourself a favor and don't

[00:06:15] [SPEAKER_00]: try to beat the market. You don't need to beat it anyway. Good enough is all you need,

[00:06:21] [SPEAKER_00]: and being average will do you just fine here. 5. What are your alternatives?

[00:06:27] [SPEAKER_00]: So what's a guy like my brother to do? He's got well over $10,000 to invest. If he wanted to,

[00:06:34] [SPEAKER_00]: he could basically invest with rock-bottom costs. The simplest thing to do would be to invest his

[00:06:40] [SPEAKER_00]: with reputable, low-cost alternatives. Naturally, anything Vanguard would do.

[00:06:47] [SPEAKER_00]: If he wanted to make it really easy, he could even invest all of his money into something like

[00:06:52] [SPEAKER_00]: the Vanguard Total Market Index Fund, or VTSAX, and call it a day. With an expense ratio of only

[00:07:01] [SPEAKER_00]: 0.05%, he'd be sitting pretty well. Another potential option would be to go with the

[00:07:07] [SPEAKER_00]: Fidelity Total Market Index Fund, or FSTVX. It's basically the same thing as the Vanguard

[00:07:15] [SPEAKER_00]: Total Stock Market Fund. Again, with an expense ratio that low, you really can't go wrong.

[00:07:22] [SPEAKER_00]: Even investing in just those funds might be too complicated for my brother. Remember,

[00:07:27] [SPEAKER_00]: he has absolutely no interest in learning about this stuff and would rather someone just do it

[00:07:32] [SPEAKER_00]: for him. Instead of giving the money to his guy and telling him to make it grow,

[00:07:38] [SPEAKER_00]: he could just go with a robo-advisor such as M1 Finance. They don't charge any management fees

[00:07:44] [SPEAKER_00]: and will help novice investors have a good low-cost diversified portfolio.

[00:07:50] [SPEAKER_00]: Takeaways. It's easy to get mired in analysis paralysis, so don't get too caught up in trying

[00:07:57] [SPEAKER_00]: to save a few tenths of a percentage point in expenses. But you've got to do some due diligence.

[00:08:05] [SPEAKER_00]: To be fair, 1% in fees probably won't be the reason you don't reach your financial goals.

[00:08:11] [SPEAKER_00]: If you're not going out and saving as much money as you can, it really doesn't matter what your

[00:08:16] [SPEAKER_00]: investment expenses are. But it's still easy enough to just avoid those expensive funds

[00:08:22] [SPEAKER_00]: altogether. My brother doesn't need to be in these types of funds, it's just a waste of money.

[00:08:29] [SPEAKER_00]: And really, to be blunt, he's being scammed. Don't just trust a guy out there to invest for you.

[00:08:36] [SPEAKER_00]: If you want to make it really easy on yourself, go with something I listed in the alternatives.

[00:08:41] [SPEAKER_00]: This investing stuff doesn't have to be hard or expensive. Save your money and use it on the more

[00:08:48] [SPEAKER_00]: important stuff. You just listened to the post titled, Why Does Anyone Invest in Expensive Funds?

[00:08:58] [SPEAKER_00]: by Kevin Ha of FinancialPanther.com. And I'll be right back with my commentary.

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[00:09:59] [SPEAKER_00]: at Fundrise.com. This is a paid advertisement. Fees can hit you from a couple of different angles.

[00:10:10] [SPEAKER_00]: There will always be an expense ratio for the investment as described in the article today.

[00:10:15] [SPEAKER_00]: But on top of that, you could also be paying AUM fees or assets under management fees to an advisor

[00:10:22] [SPEAKER_00]: who's choosing to invest your money in funds with high expense ratios. Fees compound just as much as

[00:10:29] [SPEAKER_00]: interest compounds. And so the effect is dramatic over time. For example, a DIY investor could invest

[00:10:37] [SPEAKER_00]: in a low cost index fund like VTI with a 0.04% fee and pay less than 1% of their portfolio in

[00:10:47] [SPEAKER_00]: fees over 30 years. Alternatively, someone like Kevin's brother could work with an advisor who

[00:10:54] [SPEAKER_00]: charges a 1% AUM fee and chooses to invest in an expensive fund with a 1% expense ratio.

[00:11:02] [SPEAKER_00]: This 2% fee will eat up 30% of this portfolio over 30 years. If you're not comfortable choosing

[00:11:10] [SPEAKER_00]: these low cost funds on your own, I highly recommend that you consider a flat fee advisor.

[00:11:17] [SPEAKER_00]: This is different from fee based, fee only or commissioned based advisors because they don't

[00:11:23] [SPEAKER_00]: manage your investments for you. They basically work with you on the financial plan and show you

[00:11:29] [SPEAKER_00]: how to implement that plan yourself. And you're paying them a flat fee for their time and knowledge.

[00:11:36] [SPEAKER_00]: And that'll do it for another edition of Optimal Finance Daily. Thank you so much for joining today

[00:11:41] [SPEAKER_00]: and every day. And I'll be back again tomorrow. So I'll see you there where your optimal life awaits.