Investment cost matters: cheap is good 😱

Investment cost matters, and more than you would think. But not in the way it affects other goods and services. Since childhood we are told good things cost more i.e if you want more, you have to pay more. The underlying principle is that you get what you pay for. After all most of the tangible things, we can see around us follow this principle. You need that Merc with the top of the line features and the embellished interior – you have to pay more than what you pay for a Toyota. Ditto for that mechanical watch with complications galore, it will cost you a lot more than a digital watch.

 

No wonder that when we grow up and we encounter investing cost for the first time, we use the same principle. If we are paying more to our broker or distributor or portfolio manager as investment cost, we are going to get more returns back. That somehow the tangible service we can see, pick up a cheque from home, deliver portfolio reports at home, calls about new investment opportunities etc will translate into better returns as well.

 

Of course, when that doesn’t happen we are disappointed. A lot of our investors come to Kuvera after being disappointed by failed promises of brokers and distributors, both online and offline.

 

Investing it turns out is different in two critical ways.

1/ It is not tangible. You pay the higher fees with the expectation of higher future returns. The expected higher returns may or may not crystallize, but the cost has to be born today. You are in effect paying for the promise.

2/ It is not repeatable. Not a single factor – past returns of the manager, where they went to school, what style of investing they prefer to have any bearing on the probability that they will beat the market the next year. Look at the two biggest start fund managers of 2000s and see their performance in 2010s.

 

For investing the lower your investing fees the higher returns you get to keep for yourself. In their research note “Shopping for alpha: You get what you don’t pay for” researchers at Vanguard looked at many factors — cost, fund concentration, turnover, fund size, and past performance—to determine which, if any, help indicate higher subsequent performance. They finally note,

 

 

We find cost to be clearly the most significant indicator of future alpha, with lower costs leading to higher returns, on average.

 

 

In his paper “The Cost of Active Investing” Prof French of Fama-French fame concludes,

 

 

Averaging over 1980 to 2006, I find investors spend 0.67% of the aggregate value of the market each year searching for superior returns. Society’s capitalized cost of price discovery is at least 10% of the current market cap.

 

 

That’s a very high price to pay for non-performance.

 

And throwing its hat in the ring next is research from Morningstar,

 

 

The expense ratio is the most proven predictor of future fund returns. I find that it is a dependable predictor when we run the data. That’s also what academics, fund companies, and, of course, Jack Bogle, find when they run the data.

 

 

Think of Mr Market as kind of like Liam Neeson’s character from Taken. Every day you feel like speculating, or you feel like paying that 1% more for some PMS or thematic basket or whatever the latest “investment idea” everyone is pushing think of Mr Market telling you in Liam’s baritone,

 

 

I don’t know who you are. I don’t know what you want. ..but what I do have are a very particular set of skills. Skills I have acquired over a very long time. Skills that make me a nightmare for people like you. If you let the pursuit of alpha go now, that will be the end of it. I will not look for you, I will not pursue you. But if you don’t, I will look for you, I will find you and I will take your alpha away.

 

 

 

But Mr Market does not take everything away. He will leave you with the bag of fees, costs and taxes.

 

No one is taking that away.  No kidding, eh!

 

So don’t fall for stories and promises of future riches. Keep investment costs low and enjoy the fruits of patient compounding.

 

We discuss the need to save for short-term goals and the ‘D-I-Y’ of how it can be done with Kalpen who is President DSP Mutual Funds and Kayezad who heads personal finance for moneycontrol.

 

 

 

Interested in how we think about the markets?

Read more: Zen And The Art Of Investing

 

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4 Responses

  • G

    September 22, 2020 AT 16:23

    Good read. Now to back this up please give us a ‘sort by expense ratio’ feature.


    • Gaurav Rastogi

      September 24, 2020 AT 03:44

      When you click on any fund, you can see a similar funds comparision table and that has a sort by TER.


  • Lima popal Tajik

    September 23, 2020 AT 06:17

    Can international countries citizens can invest too ? Or is this only for Indian citizens in India ?


    • Gaurav Rastogi

      September 24, 2020 AT 03:42

      Only for Indians.