Investment Philosophy and Process
Our investment philosophy and portfolio management process are anchored by three foundational tenets – Discipline, Tax-Efficiency, and Cost Control. Experience tells us that we cannot control the daily movements of the market, but we can control these three tenets and, by doing so, strive to have a positive impact on your portfolio. With each investment change we contemplate, we ask ourselves: How will this decision impact our investment philosophy, and are we staying true to our foundational tenets?
We welcome you to our blog on Cost Control, the second of a three-part series in which we’ll expand on our investment philosophy and its relevance to you. See our prior week’s blog on Discipline and stayed tuned for our next blog on Tax-Efficiency.
First, let me differentiate between the components of cost related to your portfolio. There are three layers*:
- The fee you pay your advisor for management services
- Trading costs
- Internal operating expenses tied to the funds you own
For purposes of this conversation, we’ll focus on the operating costs of the portfolio. Each mutual fund and exchange-traded fund (ETF) has a fee – known as an “expense ratio” – that is deducted to cover operating, management, and administrative costs incurred by the fund. Often times, investors do not recognize this piece of the cost equation because this expense doesn’t show up as a line item on a statement. The fund operators simply remove the fee from the gross return experienced.
*Sometimes there can be a fourth layer of fees that are dependent on the share class of mutual fund you own, known as a “load”. These loads can be upwards of 5.75% just to buy or sell! That can be a steep hole to climb out of before you start realizing true, net positive returns. One cost advantage we provide is that all the investments we purchase are no-load, meaning there are no front or back-end fees associated with buying or selling.
Importance of Understanding Investment Costs
Cost is one of the key criteria we evaluate when selecting investments. It is important that we have a deep understanding of how a fund’s cost will affect the entire portfolio. Our investment philosophy dictates that our guideline for underlying portfolio expense can be no more than 0.40%, which is extremely low considering we’ve seen outside portfolios reach up to 2%!
Now that you can identify the operating costs associated with a portfolio, let’s discuss how our investment philosophy helps us control expenses.
Our Cost Control Process
Understand how products are managed
We maintain an understanding of the management style of products we choose to own in a portfolio. Actively managed funds, rather than passive index-tracking funds, generate a higher cost – often times by a significant amount. Active management sounds great and can certainly have its place in a portfolio, but history tells us that active managers do not consistently beat their benchmarks, thus making it difficult to justify the high cost. Using passive index funds in efficient areas of the market keeps a similar risk/return profile throughout yet helps drive down cost.
Insight of product availability and strategy
Product availability and strategy also affect cost. The universe for Large Cap Equity funds is massive with thousands of funds executing this strategy, making competition fierce. It’s the very nature of that competition that drives down cost as those managers vie for investor attention and ultimately, their money. On the other side of the coin, funds using alternative strategies are often part of a smaller, niche universe. That scale of limitation allows those funds to push higher costs to investors. Our investment philosophy dictates that we use higher cost funds tactically; meaning that our research of markets and economies suggests that we use an alternative strategy to drive returns or hedge risk. Following that principle helps keep unnecessary cost at bay.
Understanding total cost will help you on your way to becoming a savvy steward of your investments. The services of Payne Wealth Partners and Keystone Financial Consulting are designed to provide clarity, confidence, and peace of mind through a planning-centric solution. Let’s start a conversation about wealth management that’s focused on what’s most important to you.
Published: March 16, 2016
Authored By: Kyle Reynolds, CIMA®