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Is a high ER ever 'worth it'?
Old 06-28-2014, 03:11 PM   #1
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Is a high ER ever 'worth it'?

So, I've been reading a lot about the lazy/couch potato portfolio strategy with the thought of simplifying my accounts across after tax, 401k, rollover IRA, and Roths.

And, I've been re-examining the approach of just using low expense ratio ETFs as well.

Now - when it comes to picking candidate funds I'm currently in, I've compared the returns and in some cases the managed funds have done exceedingly better using a 1, 3, and 5 yr comparison.

For example....

The lazy portfolio strategy is to use a total overseas market index ETF, such as Vanguard's VXUS.

I have been holding Fidelity's Worldwide Fund (FWWFX) for "international" equity exposure for several years (and prior to my serious contemplations of early retirement and deep diving into planning).

It has a high expense ratio, but when comparing it to the VXUS, it crushes.

To the crux of my question - is it ever 'worth it' to just hold your cards, not churn the portfolio and keep a high performing managed fund despite it having high ER?
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Old 06-28-2014, 03:21 PM   #2
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Originally Posted by BBQ-Nut View Post
To the crux of my question - is it ever 'worth it' to just hold your cards, not churn the portfolio and keep a high performing managed fund despite it having high ER?
Well, what valid reasons do you have to be able to confidently forecast continued outperformance for the managed fund above the higher ER? I'm sure you know past outperformance is not a valid reason, it may have been luck.

One could be that you know the manager's style and have a solid reason to assume he will stay and continue with his style. In addition, you need to understand why his style works and will continue working. That's a high bar to clear, but it can happen.

Another more mundane reason could be exit fees or tax implications.

That's pretty much it I think.
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Old 06-28-2014, 03:33 PM   #3
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It's worth it if it out performs in the future. I'm fine with active funds and paying more for something I like, but I'd like a much longer look back than 5 years unless that's all the track record there is. I usually ignore 1 year returns. An ER can reasonably be high if the fund's asset level is small. Or it could just indicate a fund company out to screw you.

Just read this at M*: Making Contrarian Investing Work

It shows you could time things by buying the worst 5 year performers and beat the market.

"Key Takeaways

  • Betting on assets with poor recent performance is a bad idea. In the short term, momentum dominates, which means that recent laggards often continue to disappoint and recent leaders remain aloft.
  • However, assets that underperform over longer periods (four to five years) eventually become cheap and poised to offer better returns.
  • Investors can take advantage of these long-term reversals with a contrarian strategy using ETFs. This strategy may work better when investors consider valuations together with the contrarian signals."
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Old 06-28-2014, 03:35 PM   #4
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It's worth it if it out performs in the future. I'm fine with active funds and paying more for something I like, but I'd like a much longer look back than 5 years unless that's all the track record there is. I usually ignore 1 year returns. An ER can reasonably be high if the fund's asset level is small. Or it could just indicate a fund company out to screw you.

Just read this at M*: Making Contrarian Investing Work

It shows you could time things by buying the worst 5 year performers and beat the market.

"Key Takeaways

  • Betting on assets with poor recent performance is a bad idea. In the short term, momentum dominates, which means that recent laggards often continue to disappoint and recent leaders remain aloft.
  • However, assets that underperform over longer periods (four to five years) eventually become cheap and poised to offer better returns.
  • Investors can take advantage of these long-term reversals with a contrarian strategy using ETFs. This strategy may work better when investors consider valuations together with the contrarian signals."
"recent laggards often continue to disappoint"

Ain't that the truth!

One reason I'm within a hair's width of dumping VWO - talk about a drag down....
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Old 06-28-2014, 04:30 PM   #5
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Well, what valid reasons do you have to be able to confidently forecast continued outperformance for the managed fund above the higher ER? I'm sure you know past outperformance is not a valid reason, it may have been luck.

One could be that you know the manager's style and have a solid reason to assume he will stay and continue with his style. In addition, you need to understand why his style works and will continue working. That's a high bar to clear, but it can happen.

Another more mundane reason could be exit fees or tax implications.

That's pretty much it I think.
Thanks for reply - valid points.

I don't have any confidence to answer your first question. I can say in hindsight (which is always perfect)...sure glad I had a stake in FWWFX vs FXUS.

Sure wish I didn't take some advice on VWO.....

Maybe the total index/low ER ETF is the 'middle ground' - it might be enough and cover the bases as someone else posted in the Monte Carlo thread between alien invasions and breathing gold plated oxygen.
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Old 06-28-2014, 04:37 PM   #6
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I am not sure why one would even compare FWWFX to VXUS (or FSGDX). FWWFX is 50% US equities and ONLY 46% international equities. Although still not a good comparison, FWWFX is closer to an S&P500 fund than it is to an international fund.

I will say that I am glad that I had US equities and international equities in my portfolio and that I rebalanced between them so that my portfolio did great.
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Old 06-28-2014, 04:45 PM   #7
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I am not sure why one would even compare FWWFX to VXUS (or FSGDX). FWWFX is 50% US equities and ONLY 46% international equities. Although still not a good comparison, FWWFX is closer to an S&P500 fund than it is to an international fund.

I will say that I am glad that I had US equities and international equities in my portfolio and that I rebalanced between them so that my portfolio did great.

Ok..fair enough...although one could argue semantics that "International" can include US equities...whatever...

To the crux of my question - high ER funds are poo poo'd - would tend to agree. But - if the track record is there, can/should they be considered at all, or summarily dismissed?
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Old 06-28-2014, 04:47 PM   #8
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Keep in mind that if you have held a high ER fund for many years and it has appreciated a lot, there will be tax consequences if you just sell it. Overall, I recommend going with low ER funds, though.
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Old 06-28-2014, 04:53 PM   #9
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Also, back in the 80's when Peter Lynch managed the Fidelity Magellan fund, most investors probably thought it was worth it (although I'm not sure what the funds ER was back then). But managers like that don't come around often and many funds have high turnover of fund managers.
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Old 06-28-2014, 05:03 PM   #10
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Keep in mind that if you have held a high ER fund for many years and it has appreciated a lot, there will be tax consequences if you just sell it. Overall, I recommend going with low ER funds, though.
Maybe not. It is possible that the annual distributions of dividends and cap gains were something that you were paying taxes on all along. it is even possible that your cost basis is HIGHER than the current value, so that you could sell at a loss. This is something that happens with actively-managed funds with high turnover.
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Old 06-28-2014, 05:04 PM   #11
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If one were to consider just the cold hard numbers - if a managed fund were to always outperform a passive ETF by more than the difference of the ERs, is it 'worth it' to hold the managed fund?

Or, are there other factors that need to be accounted for to see which is 'better' - purely from a $$ perspective?
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Old 06-28-2014, 05:06 PM   #12
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One reason I'm within a hair's width of dumping VWO - talk about a drag down....
Several successful trades of VWO were noted in the LOL!'s Market Timing Newletter Thread. It's been an awesome performer.
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Old 06-28-2014, 05:06 PM   #13
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Maybe not. It is possible that the annual distributions of dividends and cap gains were something that you were paying taxes on all along. it is even possible that your cost basis is HIGHER than the current value, so that you could sell at a loss. This is something that happens with actively-managed funds with high turnover.
Very good point.

Another question I had was that in the lazy/couch potato strategy, one is to hold "total index" type of ETFs.

Might not these ETFs also generate distributions and incur taxes contributing to one's AGI?
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Old 06-28-2014, 05:07 PM   #14
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If one were to consider just the cold hard numbers - if a managed fund were to always outperform a passive ETF by more than the difference of the ERs, is it 'worth it' to hold the managed fund?

Or, are there other factors that need to be accounted for to see which is 'better' - purely from a $$ perspective?
If in a taxable account, after-tax results are important, so taxes may be a factor.
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Old 06-28-2014, 05:08 PM   #15
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Several successful trades of VWO were noted in the LOL!'s Market Timing Newletter Thread. It's been an awesome performer.
Beg to differ when compared to say VEA
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Old 06-28-2014, 05:35 PM   #16
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The outperformance of actively managed mutual funds - of those that do - decline versus their index peers as the period of observation lengthens. By 20 years, it's a only a small percentage of funds that beat the indexes. Most end up being discontinued as their performance lags.

Understanding that high fund mortality and the difficulty in picking which funds will be the winners over time, sure, an actively managed fund would be fine in a tax-sheltered account; and maybe, depending upon your tax situation, even in a non-tax-sheltered account.

There's nothing intrinsically wrong with an actively managed account and its higher ER. Just the human fallibility of trying to beat the market. Something that's relatively easy to do in the short term. But a thing that becomes moderately difficult to do in the medium term. And exceedingly difficult to do in the long term.

Index Fund Returns Get Better With Age - Forbes
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Old 06-28-2014, 05:55 PM   #17
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Originally Posted by BBQ-Nut View Post
So, I've been reading a lot about the lazy/couch potato portfolio strategy with the thought of simplifying my accounts across after tax, 401k, rollover IRA, and Roths.

And, I've been re-examining the approach of just using low expense ratio ETFs as well.

Now - when it comes to picking candidate funds I'm currently in, I've compared the returns and in some cases the managed funds have done exceedingly better using a 1, 3, and 5 yr comparison.

For example....

The lazy portfolio strategy is to use a total overseas market index ETF, such as Vanguard's VXUS.

I have been holding Fidelity's Worldwide Fund (FWWFX) for "international" equity exposure for several years (and prior to my serious contemplations of early retirement and deep diving into planning).

It has a high expense ratio, but when comparing it to the VXUS, it crushes.

To the crux of my question - is it ever 'worth it' to just hold your cards, not churn the portfolio and keep a high performing managed fund despite it having high ER?
Seems like you have already answered this question. Obviously it was worth it for these funds and this time period.

Will the same hold in the future. I don't know.
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Old 06-28-2014, 06:22 PM   #18
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It does not matter over 2 plus years of lifetime of VXUS. Compare FWWFX to SPY over last 20 years. FWWFX is a dog......

And once you have 20 years of VT (which closer to FWWFX) it will most likely outperform.....
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Old 06-28-2014, 06:23 PM   #19
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Beg to differ when compared to say VEA
A buy of VEA was also mentioned in the LOL! MT thread: LOL!'s Market Timing Newsletter Could my timing be improved? Of course!
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Old 06-28-2014, 07:24 PM   #20
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I think that you missed LOL's point. You need to be very careful in comparing the performance of different funds and make sure they are sufficiently similar.
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