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Friday, April 17, 2009

How to Invest for Less

In a down market, especially when many investment portfolio values have been slashed by 30 or 40 percent over the course of a year, it’s become painfully apparent that a large part of those losses comes in the form of the fees you pay to invest your money. Over a period of several decades, from first investment to retirement, investment costs can eat up tens and even hundreds of thousands of dollars, destroying the real rate of return of a mutual fund.

For example, an initial investment of $50,000 over a period of 25 years at 8% would grow to $342,423. However, if the gains are 6% annually due to management costs and related fees, that number drops to $214,593 - a difference of $127,830. Even a difference of one percent can be huge over time - in 35 years, receiving 8% annual on $50,000 yields 739,267; compare this to the 533,829 from a 7% return on the same money.

For the average investor, most investment fees fall into one of three categories: mutual fund expenses, investment advisor fees and brokerage commissions, the per-transaction trading fees for buying and selling individual stocks. Mutual funds have some of the highest expenses, with exchange-traded funds (ETFs) usually somewhat lower.

But even ETF fees are not immune to change. According to Richard A. Ferri, CFA at Portfolio Solutions, LLC, “During the 1990s, new issue ETF fees averaged about 0.25%. Over the past few years new issue ETF fees were closer to 0.60% and this year the fee is closer to 0.80%. In addition, some of the more complex ETFs issued a few years ago capped their fees below the stated prospectus level. Those caps are starting to expire and fees are rising.”

Still, since they cost significantly less than mutual funds with high commissions (loads), low-cost index funds and ETFs are the better way for investors to get the same exposure to the financial markets without losing as much of their money in fees, said Ferri.

To maximize your savings and return on investment, Clint Gharib, Vice President of Investments at Turner Wealth Management, LLC, also recommends that you work with an independent, fee-based advisor. “Independent registered advisors provide access to a much wider range of investment products and services with no proprietary products to promote. An investment advisor must act in a fiduciary capacity on behalf of their clients, therefore providing a higher standard of disclosure than in a traditional securities brokerage environment. Because the financial representative gets a flat annual fee based on the amount of assets rather than a commission, transactions themselves do not benefit an advisor,” said Gharib.

Ferri agrees, saying, “Fire that high cost advisor. Advisors’ fees are the last bastion of gluttony in the investment business. They are simply too high. The advisors that charge 1% or more to manage a portfolio insist that they ‘add value’ though their investment selection. There is no academic evidence suggesting that paying high advisor fees provides any benefit over using a low cost advisor. In fact, high fees hurt your bottom line on a dollar for dollar basis.”

You can also save money by using discounted brokerage services instead of those with high per-transaction costs. Lowering these trading costs will help bring down your overall fees and improve your investment profits.

Jeff Nabers, CEO of Nabers Group and founder of the IRA Association of America, takes his investment theory a step further than simply trying to lower investment fees for Wall Street portfolios.

“The real cost of investing is poor investment performance due to lack of understanding and awareness that IRAs and 401ks do not have to be invested in Wall Street products,” said Naders. While investors think they are diversifying by buying a variety of stocks and funds, history shows that when the stock market goes down, all sectors of the market go down. The better option, he explains, is to get off Wall Street and thus actually diversify your investments.

Nabers, who is currently writing a book titled Unlimited Investing with a Self-Directed IRA LLC or Solo 401k: Break Free From Wall Street to Build Real Wealth with Alternative Investments, considers Wall Street somewhat of a casino when it comes to investments. In contrast, there are many other, better ways to invest money for retirement; for example, real estate, precious metals and small businesses.

Real estate prospectors of the past few years who bought based on the hope that their properties would increase in value and they could sell for a profit give real estate investing a bad name. The difference between them and successful real estate investors is in the verb, said Nabers. Profitable real estate investments are the product not of hoping, but of planning. Let’s say you want a minimum 10% annual return on investment (ROI) for your real estate purchase. You would look at properties, from apartment buildings to duplexes to single-family units, and make real calculations of what the properties will earn or cash-flow each year, based on area rents, factoring in taxes, mortgage payments, property management fees and the like.

After analyzing a number of properties, you would know which could provide the ROI you desire and plan your investment accordingly. That’s the difference - planning, not hoping. Stocks used to be the same way, where people bought them based on the dividends they produced and not simply for capital gains.

Investments that qualify for retirement plans are nearly limitless, said Nader, naming just life insurance, collectibles and self dealing as things that are not allowed. The sooner investors look outside the small box of Wall Street and actually diversify with sound, researched investments, the more they will avoid the high cost of investing found in fees and poor portfolio performance.

Looking for a fresh approach to investing? As an investor, be wise about your money. Avoid high-cost mutual funds and expensive investment advisors, choosing low-fee ETFs and fee-based services instead. On top of that, consider moving some or most of your money off of Wall Street and into carefully researched alternative investments.