Article by Alan P. Weiss, CFP®
Published in the May 22, 2016 New Haven Register
In today’s low-interest environment, we need to be more aware than ever of the investment costs in our portfolios.
Whether it’s your 401K plan or personal investments, keeping your costs down is important. You can buy low-cost mutual funds from companies like Vanguard or buy funds that have a 12b-1 fee, which is considered an operational expense and, as such, is included in a fund’s expense ratio. This is generally between 0.25% and 1% (the maximum allowed) of a fund’s net assets.
Even no-load funds may charge a service fee of up to 0.25%. The fee is efficiently passed on to the individual and diminishes his or her overall return.
Your expense ratio might be somewhere between 0.5 and 2%, which doesn’t seem like much. However, just as compound interest magically accumulates at an exponential rate over time, so does a 2% expense ratio that works just as hard against you. So when you pick funds, pay close attention to the expense ratios.
If you are working with an advisor, knowing how that advisor gets paid is also important. If the answer is not clear to you, remind yourself: This is your money and you should understand where it’s going.
Equally important is understanding risk tolerance versus risk capacity. Risk tolerance is a measure of our psychological desire to engage in risky trade-offs – one’s willingness to accept the possibility of a less favorable outcome in pursuit of a better one. Some people are willing to take many steps backward if it gives them the potential to take even more steps forward – a classic expression of having a high tolerance for risk. Others are more conservative; they’d prefer to just take baby steps forward to avoid the danger of ever needing to take a big step back.
Accordingly, those with a higher tolerance for risk are generally willing to take on riskier investments, while those who are risk-averse prefer more conservative portfolios.
By contrast, investors evaluating potential risky-or-not investments must also evaluate their risk capacity, which is a measure of their ability to actually achieve their goals if one or more of those risky investments doesn’t work out. In other words, regardless of how you feel about risk, if “bad stuff” happens, what would be the impact on your goals and could you still achieve them?
Alan P. Weiss is the president of Regent Wealth Management Group in Woodbridge. He is also a CERTIFIED FINANCIAL PLANNER™. Readers are reminded that certain investments and investment strategies may not be appropriate for them and that all investments involve risks and uncertainties. Consult an expert of your choosing if you have questions about investments. More information is available at www.regentwealth.com.)