When it Pays to be Passive Aggressive

I know many of you are dedicated Costco and Sam’s Club shoppers. You are all about getting deals and saving money.

Are you just as focused saving money on your investments?

The good news is that it has never been a better time to save money on your investments. The common annual fee charged on all mutual funds and exchange traded funds keeps falling. Morningstar reports that the average asset-weighted annual charge – called the expense ratio – is now around half of what it was in 2000. The average 0.48% expense ratio in 2018 saved investors an estimated $5.5 billion, compared to the average cost a year earlier.

That’s all fantastic news, but only if you are cashing in on the funds and ETFs that are on sale.

It is easy to find the annual expense ratio for a fund or ETF. You can check your brokerage website or call customer service. Or a quick online search of the name of the fund or ETF will connect you to information pages which will include the annual expense ratio.

I want you to seriously reconsider any fund or ETF that costs you more than 0.20%. Yes, that’s a lot lower than the 0.48% average I just told you about, but that 0.48% includes two very different types of funds and ETFs:

Active funds: These portfolios are where investment managers make decisions about what to buy and sell. The average expense ratio for active funds was 0.67% in 2018, according to Morningstar.

Index funds: These portfolios track a benchmark index. There is no manager “actively” making investment decisions. The average expense ratio for index funds in 2018 was 0.15%

Index investing is often referred to as “passive investing.” It is the best way to invest. Study after study shows that very few actively managed funds manage to consistently do better than index funds. It makes no sense to pay for something that doesn’t deliver a better return. That’s why I want you to be very aggressive in being a passive investor.

I am all for having all your money invested in low-cost index funds, mutual funds or exchange traded funds. The savings over the years will make a big difference.

If you own a fund or ETF with an above average expense ratio in a retirement account, you can move to another fund or ETF without any tax bill.

If you own an expensive active fund in a regular account, selling it to reinvest in a less expensive fund will trigger a tax bill if the account is now worth more than what you contributed. It may still be worth it to make the move. A portion of your taxable bill may qualify as long-term capital gains –typically a lower rate than your regular income tax rate. And keep in mind that you’ve likely been paying taxes every year on your investment, as many active funds generate annual tax bills. That effectively reduces the tax bill you will owe, if you sell.

You want to weigh the one-time tax hit with the potential savings from owning a lower-cost fund. For example, a $10,000 investment in a fund that charges 0.15% and earns an annualized 6% will be worth around $23,500 in 15 years. If the same $10,000 is invested in a fund charging 0.70% it will be worth about $21,700. That’s nearly a 10% difference, just because you took the time today to invest in lower cost funds and ETFs.