Hello, my name is Ronnie and I am a control freak ...
<insert chorus of "Welcome Ronnie" from the rest of my assembled control freak brethren>
If there were such a thing as Control Freaks Anonymous (I don't think there is but I could be wrong), we would begin by reciting the Serenity Prayer:
"God, grant me the serenity to accept the things I cannot change,
The courage to change the things I can,
And the wisdom to know the difference."
As a recovering control freak, I have to constantly be on guard for letting my desire to control things outstrip my ability to actually do so. This is seldom more true than in the world of saving and investing, where there is much beyond my control and very little (comparatively) within it.
When swimming in the sea of our financial lives, the ability to recognize that which we cannot control is key and sometimes there are nuances to that recognition. For example, I can't control market interest rates, as I am not in sole control of the Federal Reserve. I can however control, through research, where I put my money in order to get the best interest rate available to me.
Given what's been going on the last few weeks and months in the global economy, I thought the timing might be right for reminding myself and my fellow control freaks about a few of the things we can and cannot control in our saving and investing activities. Let's begin with the things we can't control, since those are the most unpleasant and we want them out of the way first:
What We Can't Control
- Market volatility - The market and its corresponding indices covered in the media (Dow, S&P, NASDAQ, etc.) are going to change every minute of every hour of every trading day and there's not a thing we can do about it. Like a perpetual roller coaster, we must resign ourselves to the ride if we're going to be in the market at all. Whether you should be in the market at all is a topic for a different day...
- Interest Rates - See previous example. The savers among us would love to see higher interest rates, the borrowers want to keep it lower. Suffice to acknowledge that we can't control the prevailing rates and move on as best we can.
- Wall Street and Corporate Behavior - The big banks, investment firms, corporate CEO's, and their executives are going to do what they're going to do, which is to do their best to squeeze as much money out of the system (and us) for themselves as possible, in any way they can come up with. It may be illegal or immoral, but they're going to do it and we won't know about it until after the fact.
- Taxes, Now and in the Future - Taxes are a necessary evil of modern life and you're going to have to pay them. Sooner or later and in some form or another, you'll pay them and you can't let avoiding taxes control your every decision. What rate you might pay for a given circumstance, particularly when thinking about a retirement horizon that might be 30 years away, is ridiculous to consider since nobody knows what the situation will be then. Remember, you can be guided by tax implications but your actions should not be dictated by them.
Now that is by no means an exhaustive list of what we cannot control (feel free to add your own in the comments below) but it's a few highlights. The trick is to truly realize we can't control them and not let that get in our way emotionally or psychologically. Now let's shift to the more pleasant things, that which we can control.
What We Can Control
- Spending - All spending is discretionary to one extent or another. Sure there are expenses you can't avoid like food, clothing, shelter, etc., but you can control how much you spend on them. Some expenses are fixed in the short term but can be changed later, like being 6 months into a 12 month lease on an apartment; you can't control it for the remaining 6 months but you could move somewhere less expensive later. You don't need the latest iPhone and you won't die of starvation if you don't shop at Whole Foods. Spending is something you have a great deal of control over.
*Side Note: never,ever, be ashamed or embarrassed about clipping and using coupons. Whether things are very tight for you or you're rolling in money, coupons are awesome if you can use them for the things you want, particularly groceries and meals out.
- Saving - When combined with changes in Spending, our ability to save is our most powerful investment tool. We control what we do with our savings in terms of our emergency fund and where we put it to have easy access but still get a decent interest rate. We control where and how much we devote to retirement savings, our kid's college fund, or just saving for a new car or improvements to the home.
- Income - We have a degree of control over our income, whether that's asking for a raise in our current job, a promotion, changing companies, getting some extra education and changing careers, or, in a pinch, getting a 2nd job delivering pizza. One way or another, we do have some control over our income and using that control will impact other areas of our lives, notably Saving and Spending.
- Taxes - Yes, you read that right. Taxes shows up in both categories because while you can't control them to the point of never paying them, you do have some degree of control over when and how much you might have to pay, depending on your individual circumstances. Deferring income to a subsequent year, using a ROTH IRA instead of a Traditional IRA, judicious use of an FSA or an HSA for healthcare expenses, etc. Your accountant or financial planner can give you some advice on this sort of thing but there is some control to be had. It's not ultimate control, but it's better than nothing.
The thing we control freaks must admit and adjust to is that much of life is beyond our direct control. We must accept that fact and let it go, being content to control what we can to achieve our desired outcomes. In saving and investing, like many other things in adult life, there is no option to take our marbles and just go home, refusing to play the game. To have any chance at things like a reasonably comfortable retirement, a decent roof over our heads, etc., we must play the game the best way we can. This sentiment is summed up very succinctly, at least for me, by one of my favorite movies in the following line:
"There's no sense asking if the air's good when there's nothing else to breathe ..." Henry II, "The Lion In Winter"
You think your mutual fund investment is a good deal because it only has an Expense Ratio of say 0.9%? Maybe or maybe not. You might actually be paying a good deal more than that and you don't know it...
All mutual funds have to tell you how much participating in their fund will cost you and you'll generally find that information in a "Fees & Expenses" section of a prospectus or the fund profile on Yahoo! Finance. In addition to the Expense Ratio, there are also potential sales loads, 12b-1 fees, etc., but the focus of this article is an implied cost and can only be hinted at in something known as the "Turnover Ratio".
The Turnover Ratio is a measure of how many times the total value of the portfolio in the fund gets traded during the year. A Turnover Ratio of 150% means that the total value of the fund will "turn over" 1.5 times during the year. The higher the turnover ratio, the more trading the manager is doing in pursuit of investment returns.
Trading is done by the fund manager in an attempt to buy low,sell high, find bargains, and ultimately to "beat the market" or at least beat the index by which the fund measures itself, like say the S&P 500. The costs of these trades can't realistically be disclosed up front like the Expense Ratio or other fees because you never know how much trading will be done, with which trading partner, and what those costs might add up to. Make no mistake however, trading costs are a drag on your return and some are worse than others.
For an example, let's randomly choose a fund to examine, say the Schwab Large Cap Growth fund at the following link: http://finance.yahoo.com/q/pr?s=SWLSX+Profile
In the "Fees & Expenses" section you'll find that this fund has a Prospectus Gross Expense Ratio of 1.04% (as of this writing). There are no sales load fees or 12b-1 fees associated with this fund, so you might expect that your costs would only be that 1.04% per year, roughly $104.00 per $10,000 invested.
In the "Fund Operations" section, you'll see the "Annual Holdings Turnover" of 82%. So at that level, just 18 points shy of a 100% turnover, there is definitely some serious trading going on. We know they're paying something to make those trades, but what is that costing you in terms of your total return?
Research from the Financial Analysts Journal (link below) published in 2013 indicates that trading costs can reach levels equal to or even greater than the stated expense ratio. You are of course welcome to read the research yourself but a summary table can illustrate the point:
Link to original research: http://www.cfapubs.org/doi/pdf/10.2469/faj.v69.n1.6
Continuing with our example of SWLSX and consulting the table above, a Large Cap Growth fund from the study has a Turnover Ratio of 89.3%, which is fairly close to the 82% of SWLSX. That same category has an Average Trading Cost of 0.97%, which is in addition to the stated Expense Ratio of 1.04%, for a total potential expense of +/- 2.01%, which is not quite double what you thought you were paying in expenses.
So, generally speaking, the higher the turnover rate in a fund, the higher the trading costs will be. In specific categories those costs can be little more or a little less but it's an easy to understand idea and the costs to the investor are real. It may not sound like much for any one year but remember we're talking about investment horizons that can be 30+ years out, so those costs compounded over time can cut very deeply. The larger your portfolio, the larger these costs will be and the greater your compounded returns will suffer.
None of this is meant to dissuade you from using an active management strategy but to give you more information to inform your decision. This data doesn't cover all categories and of course the last of the data set was from 2006. Things have changed since then, expenses have come down, markets have changed, etc. Just know that trading incurs costs and those costs come out of your investment returns, either explicitly or implicitly. As I was reminded by an old cartoon from my childhood: Knowing is half the battle. That sentiment is particularly true of investing. Know what you're getting into before you get into it, so you can more accurately gauge your expectations.
How do you avoid these costs and keep more of that money for yourself? Different people and advisors will have a different opinions of course, so your mileage may vary. For myself, I recommend an index fund approach, which keeps both the expense ratio and turnover to a minimum. I do give up the chance that my index fund will ever beat the market but I always know I won't really be much below the market either; such is the nature of index funds. That however is a subject for a different day.
Recently a friend had her checking account cleaned out due to debit card fraud. It’s a painful and aggravating experience to go through and I wouldn’t wish it on anyone (except maybe a politician or two I know).
The primary difference between debit card fraud and credit card fraud is that with debit cards, your own cash gets wiped out. While you can eventually get the charges reversed like you can with a credit card, the process doesn’t necessarily happen as quickly and, while you’re waiting, you’ve got nothing in the bank. That’s a problem if you have checks outstanding, automatic bill drafts scheduled to happen, etc.
The T.J. Maxx data breach in 2007 that exposed the payment information of thousands of customers resulted in $150 million in fraud losses, and most of it was pulled directly from customers' bank accounts. While credit card users got their accounts straightened out and new cards in the mail within a few days, the case created huge problems for debit card holders, who waited an average of 2 to 3 months to get reimbursed. Could you wait that long for your money if they coincidentally hit you right on your payday?
Debit Card fraud is very preventable if you follow a few simple rules:
1. Don’t use a debit card, period. Use a credit card. Why would I recommend this? Because with a credit card your tools for fighting bogus charges are set in law and the dispute procedures are implemented like a well-oiled machine with all the major card vendors. When they steal from your credit card, it’s not YOUR money at that point they're stealing, it’s the bank’s money. Your ability to pay your bills is not endangered.
2. If you use a debit card, only use it at terminals indoors and at places you trust strongly. Never use a debit card at an outdoor ATM, gas pump, or an ATM that isn’t bank-branded. Certainly don’t use it in those cash machines in a convenience store, etc.
3. Don’t use a debit card for online purchases, EVER. With websites being hacked and other breaches, you are MUCH safer using a credit card. If nothing else, get one of those re-loadable cards and use those for online shopping so that if they do steal that info, the damage is limited to however much you loaded on it.
4. Don’t have your debit cards tied to the account where your emergency fund resides. If they clean out your checking AND your savings/emergency fund, you’re really bent over a barrel.
A certain popular radio personality decries the use of credit cards and says using a debit card is exactly the same. While I really do like a lot of what this guy preaches, on this one he’s dead wrong. Sure, using the cards anywhere is just like using a credit card, and as long as everything stays kosher it’s not a problem. But when it comes to billing disputes and getting charges reversed, there is a world of difference. Will your bank work with you on getting bogus charges reversed? Of course they will, but how long will it take before you get YOUR money back into YOUR account? It might be quick but it also might be longer than you might be able to stand if your budget runs lean.
Remember, with credit cards you’ve got federal law on your side, with debit cards you do not. For more background information and tips for disputing charges to your debit card, see this article.
Stay safe out there folks.