Most investment advisors measure their success by a yardstick called assets under management-the amount clients have entrusted them to invest. Mitch Tuchman is more interested in the dollars he’s been able to bring “out of management.”
That’s Tuchman’s shorthand for the dollars that his company’s website, MarketRiders.com, has helped clients move out of high-fee brokerage firms and actively managed mutual funds and into the low-cost realm of exchange-traded funds (ETF).
ETFs are similar to mutual funds, with the key difference that you can buy and sell them like stocks. The most popular ETFs track broad segments of the stock market, such as the S&P 500, although you can buy ETFs that track the bond market, currencies, commodities or just about anything else. And in most cases, the cost of investing in an ETF is very, very low.
Tuchman is one of several Silicon Valley entrepreneurs who have spotted the opportunity to use Internet-based technology to give retirement investors better transparency and tools to analyze expenses. Another example is Brightscope.com, which focuses on the 401(k) market (see my earlier column on Brightscope at http://bit.ly/93G7xo)
MarketRiders is an advisory service that charges $100 annually to help investors identify ETF investments, and assist with rebalancing. Although Tuchman is a registered investment advisor, his clients handle trading through their own separate discount brokerage accounts.
Many retirement investors are just starting to understand the damaging impact that fees can have on their portfolios. A Morningstar study released earlier this year found that fees trumped even the investment firm’s vaunted star rating system as a predictor of success; low-cost funds reviewed by Morningstar had much better returns than high cost funds across every asset class from 2005 through March 2010.
Morningstar found that domestic equity funds with the lowest cost in 2005 returned an annualized 3.35 percent over the time period studied, compared with 2.02 percent for the most expensive group. Likewise, A 2006 report to Congress by the U.S. Government Accountability Office (GAO) found that a one-percentage point increase in fees reduced return over a 20-year period on a typical portfolio by 17 percent.
Those numbers bolster the case for ETF investing. The average ETF charges just 0.53 percent in annual expenses, compared with 1.42 percent for the average U.S. equity mutual fund, according to IndexUniverse.com-and many ETFs charge fees far lower than that. MarketRiders, for example, says the ETF fund fees in client portfolios average just .17 percent.
ETFs also are more tax efficient than traditional mutual funds because they’re structured in a way that generates very little capital gains liability for investors.
The first ETFs were created in the early 1990s, and started off as a small sector of the investing world. But they’ve really taken off in the past decade, and have seen spectacular growth in the past five years. Total assets in ETFs stood at $800.9 billion at the end of August, up from just $300.8 billion at the end of 2005, according to the Investment Company Institute.
That’s less than 10 percent of the total amount invested in mutual funds, but mutual fund investors are shifting decisively toward low-cost products, too. A Vanguard study released earlier this year found that 86 percent of cumulative cash flowing into equity mutual funds in the 10-year period ending in 2009 went into the lowest-expense quartile of fund offerings.
“The average investor is starting to get it,” said Allan Roth, founder of financial advisory firm Wealth Logic and author of “How a Second Grader Beats Wall Street: Golden Rules Any Investor Can Learn” (John Wiley & Sons, 2009). “You really can harness significantly higher returns from lower fees and tax efficiency.”
Roth advises clients to build ultra-simple portfolios with three to five ETFs. “You need a total U.S. fund, a total international fund, and a total bond fund. Very few portfolios will need diversification beyond that. We don’t buy anything with fees over .25 percent, and we rebalance as needed.”
ETFs likely will get another big boost from recent decisions by major brokerage firms to eliminate commissions on ETFs. The boldest move came from TD Ameritrade, which in October launched a zero-commission ETF platform that allows investors to buy more than 100 ETFs commission free, so long as the investments are held for at least 30 days. That came after the announcement of more limited commission-free offerings from Charles Schwab, Fidelity Investments and Vanguard.
The price wars are music to the ears of Tuchman, who launched MarketRiders in 2009. He comes out of a background in Silicon Valley venture capital and technology businesses, and came up with the idea while working at a hedge fund. “I’m an M.B.A and math guy, but I would talk with wealth managers and couldn’t make sense of what they were saying. In their model, fees would consume a third of returns.”
Tuchman says MarketRiders.com has attracted 5,000 portfolios to its system, and now has a half billion dollars “out of management.”
Mark Miller is the author of “The Hard Times Guide to Retirement Security: Practical Strategies for Money, Work and Living” (John Wiley & Sons/Bloomberg Press, June 2010). Contact him with questions and comments at mark@retirementrevised.com.
