Tuesday, November 6, 2012

Schwab Misleading Investors About ETF Costs


Schwab Misleading Investors About ETF Costs
                                          Nov. 6, 2012


I was watching a football game last Sunday and on comes a commercial from Charles Scwhab about how they offer the lowest cost Exchange Traded Funds (ETF's). They showed a comparison between their ETF's and the industry average and their cost of .004% cost was the lowest in the investment industry.  If that was all there was to costs that might be impressive, but the fact that they excluded a bunch of other costs associated with ETF's makes it misleading.


First, what is an ETF? An ETF is fund that mirrors a particular segment of the market. For example, an investor could own a fund that is identical to the S&P 500, but unlike a true index fund an ETF allows an investor to actually trade one segment of the market for another segment of the market. For example, today you could hold an ETF that mirrors the S&P 500 and if tomorrow you think the more attractive market is U.S. Small Company Stocks you sell your ETF in its entirety and buy the U.S. Small in its entirety. It's a quicker way of moving from one market to the other.


Getting back to Schwab misleading investors, ETF's include all the costs associated with an actively trading invetment strategy. The .004% Schwab is referring to is just the tip of the iceberg.

The key word here and why brokerage houses promote ETF's is, Traded. Remember how brokerage houses make money. They make it off of trading securities. How in the world could Schwab afford to put a commercial on prime sporting events on just .004%?
On a $100,000 investment, that .004% equates to $40. You could barely afford to put an ad in a local newspaper if that was all the revenue the brokerage house was bringing in.


So what are some of the costs in actively trading ETF's?

There's commissions. Just like when a stock is traded individually or through a mutual fund there is an expense that is imposed on that transaction and that same commission expense applies to ETF's. There are also Bid/Ask Spreads. When an investor places a trade in addition to the commissions that are paid, the trade also has to go through one of the brokerage houses's market makers.


Think of the market maker as any other business owner with an inventory to buy and sell from. When a customer comes along, the market maker tacks on an expense to the sale in order to make a profit. When the market maker buys back an ETF to add to their inventory they mark down the price so that when they put the ETF back on the market they can sell it at a price that they can profit from. None of the costs were mentioned in Schwab's commercial and if the an investor took the ad at face value they'd have no idea about all the other costs they'd be paying and how they will impact on their returns.


None of these costs metioned even begins to shed light on the costs investors will absorb by participating in the trading of their ETF's. There is no mention of the fact that trading securities on an active basis is gambling and the expected rate of return on gambling is 0%. After absorbing all the costs the return is negative. Hence, promoting solely the costs of holding the fund is completely misleading to the investing public.



Brendan Magee is the founder and president of Inevitable Wealth Coaching in Drexel Hill, Pa. With questions or comments call 610-446-4322 or e-mail brendan@coachgee.com.

Friday, November 2, 2012

Certainty And Disppointing Returns Go Together


Certainty And Disappointing Returns Go Together
by: Brendan Magee
Nov. 2, 2012

A very nice man shared with me that he had been disappointed with the results of his investments. He told me that over the past five years his account had only gone up by about one hundred dollars. He showed me his statement and asked if there was anything I could do to help.


As he handed me his account statement he told me this was all the money in the world he had and  since he was retired he couldn't afford his account to suffer any losses. Thus, when we looked at his account holdings, all the money was in a certificate of deposit.

Like a lot of people who have their money in certificates of deposit their was not a lot to celebrate in terms of return.His annual yield to maturity was a mere 0.95%. When you factor in the rising cost of living over the last 20 years at 2.80%, the value of his money wasn't going up by 0.95% on annual basis, it was decreasing by 1.85% every year he kept his money in that certificate.


However, his biggest investment problem was not losing value on his life savings every year. That was symptomatic of a bigger problem he has no clue about.


Our friend was looking at his investments looking for an investment solution when all the while his investments actually have an investor problem. The bigger more damaging problem he alluded to as he handed me his account statement. "This is all the money I have and I can't afford to take any losses," is masking his problem. Our friend cannot live with (is scared to death of) any negative returns. He cannot live with any uncertainty, uncertainty that comes from depositing any of his money into equities (stocks). In this man's case he cannot see that FEAR is making his investment decisons for him and he's paying a huge price for it.


Let me make this clear he will pay a price no matter what he does, a much higher price than money can offset. If he says to himself, I am tired of seeing my money lose value, his alternative is to commit some portion of his portfolio to investments that do not guarantee his prinicpal. From year to year he will be living with the thought that he could see statements that reflect a decrease in his account balance.


The question is how much uncertainty can he live with. Can he go to bed at night and sleep comfrotably knowing that 10, 20,30, or 50% of his money is exposed to the volatility of the stock market? We already know the price he is paying for complete certainty. The value of his money can do nothing but go down with all of it being deposited into his ceritificate of deposit.


The thing that really limits his options and leads to poor decisions is not asking the appropriate questions. For example, he needs to ask about his life expectancy. Rather than thinking from year to year, what if he realized he needs to be concerned with his money lasting over the next 25 years? What if he looked at how poorly investments that have a 100% certainty of principal have done when compared to the rising cost of living as opposed to the stock market?

Would it make it any easier if he had a better understanding of how to apply diversification to his portflio? Would he draw courage from seeing that when he makes use of investments that offset one another under different economic conditions that risk can be controlled?


More critical than all of these questions, is asking what purpose is he out to fulfill on with his money? In other words what is it that he is out to create with his money? Answering those questions will give him energy and passion, not answering them has him holding on to his money for dear life and his money is actually running his life.


Brendan Magee is the founder and president of Inevitable Wealth Coaching. with questions, comments or suggestions call 610-446-4322 or e-mail brendan@coachgee.com.