Driving In Traffic – A Metaphor For Fund Fees And Performance

Editor’s Note: A version of this post appeared in the San Antonio Express News in my brand spanking new “So…Money” column.

 

My morning commute this summer means driving the two young lovelies to their respective kid camps. I like driving in heavy traffic as much as I enjoy hauling over-heated kitchen garbage out to the brown bin in the garage in August. Which is to say, I often have my crinkled-nose sad face on when commuting.

One benefit of being stuck in 8 a.m. traffic headed north on U.S. 281, however, is the chance to reflect on my favorite analogy about investment fund fees and risky markets.

Picture me in traffic, in my dark red — although for my own pretentious reasons I insist friends refer to the color of my car as “Crimson” — Hyundai Elantra. This hot number accelerates from O to 60 in just under 4.3 minutes.

[By the way, please open and press play on this YouTube link in another browser, as it constitutes the preferred musical accompaniment to this entire post. This is meant to be a multi-media experience. Thank you.]

hyundai_elantra_like_an_index_fund
Hyundai: The “Index Fund” of the Car World

So we’re crawling along around 3 miles per hour, and I glance over my left shoulder at the electric blue Corvette next to me.

A key fact to know, which hardly needs spelling out, is that the owner of that pretty blue Corvette paid approximately three and a half times what I paid for my Hyundai.

I exchange a “Whaddyaknow?” grimace in solidarity with the middle-aged man behind the wheel of his sports car, since we’re both stuck behind a few miles of bumper-to-bumper commuters.

My investment fund fees analogy hinges on the key fact that my crimson Hyundai and my buddy-in-traffic’s electric blue Corvette are in the process of accomplishing exactly the same thing, despite an obvious difference in price — and an obvious difference in status.

blue_corvette
Shiny, fast, and expensive!

Because both of us are moving nowhere fast.

Now, here’s my great traffic and investment fund analogy in full:

With your investments, your primary goal is to get from point A to point B. Specifically, to turn some amount of money you have today into some larger amount of money in the future.

The speed at which traffic flows is the market returns of any given year.

Sometimes you’ll flow along nicely up 281 at 65 miles an hour with not much traffic. That’s like earning a cool 12 percent from the stock market for the year without breaking a sweat.

On other occasions you’ll ease onto the nearly empty Pickle Parkway — also known as State Highway 130 — and legally cruise at 85 miles an hour. That’s what it feels like to earn 20 percent or more from the stock market.

And then, in the worst times, you’re stuck behind a four-car pileup, sweating and swearing and unable to move or even get off the highway. We had that kind of year in 2008, when everyone in stocks lost about 35 percent.

Here’s where my analogy really kicks in, though. For the vast majority of driving situations, like the vast majority of investing situations, we get what everybody else gets and there’s not much we can do about it.

As my daughters’ pre-school teachers like to remind them: The best (investing) attitude is ‘You get what you get and you don’t get upset.’ Maybe you already know this idea, and you set it to good use when you buy an investment fund. But I know most of us don’t act like we know it.

Practically the entire personal investing industry is built on the false conceit that you, the consumer, can buy a financial vehicle that can go faster than someone else’s vehicle — essentially to “beat the market.” In reality, that’s incredibly rare.

Without breaking the law, heading onto the shoulder lane or driving recklessly at an elevated risk of hurting yourself or others, you cannot generally beat the rate of traffic, whether you drive an electric blue Corvette or a crimson Hyundai Elantra.

And the same goes for investment funds. You can pay more for a mutual fund or hedge fund, but almost none of them reliably “beat the market.” Every rigorous academic study of financial funds ever done concludes this way: The difference in market returns between high-cost and low-cost funds is, in aggregate, the cost of the funds’ management fee. The difference in market returns, in aggregate, favors the low-cost fund.

Traditional mutual funds charge between 0.75 percent and 1.5 percent management fees, or between $750 and $1,500 per $100,000 investment per year. If you buy an index fund — the Hyundai Elantras of the investment world — you will pay between 0.1 percent and 0.5 percent management fees, or $100 to $500 per $100,000 in the account.

ridin_dirty_hyundai_elantra

The entire financial industry would like you to think that the extra cost buys you something, but I’m here to tell you the straight fact that you’re paying three and a half times more to get exactly the same investment performance.

Whaddayaknow?

 

Please see related Posts:

On Cars Part I – On Avoiding Excessive Fleecing

On Cars Part II – Acceptable Price of a Car

 

 

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I founded Bankers Anonymous because, as a recovering banker, I believe that the gap between the financial world as I know it and the public discourse about finance is more than just a problem for a family trying to balance their checkbook, or politicians trying to score points over next year’s budget – it is a weakness of our civil society. For reals. It’s also really fun for me.

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