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Principles of Finance: Unit 2, The Math of Fees 3 Views


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So what's the math involved when figuring out fees? How much cash should a mutual fund have on hand? You've got questions - we've got answers.

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Transcript

00:01

No principles of finance ah la shmoop the math of

00:07

fees All right well now that we've learned about how

00:10

they stack up the benjamins let's get down to the

00:12

reason that mutual funds exists all right couple reasons here

00:16

first they allow individuals to gain exposure to a wide

00:20

range of investment vehicles without having to invest like eighteen

00:24

billion dollars in a jillion different stocks to do so

00:27

well Second mutual funds exist because well there was a

00:30

time in history when actively managed funds handily beat the

00:36

passively managed or unmanaged world of index funds or the

00:40

stock market and they beat it by a wide enough

00:43

margin that the spread more than covered the fees and

00:46

taxes that the mutual fund industry charge But well that

00:51

isn't true anymore in today's fastly more competitive than the

00:54

world of nineteen sixty eight world So why do people

00:59

still invest and actively managed mutual funds Good question there

01:04

weeks psychology They need the emotional hand holding When the

01:07

market has a bad hair day they didn't watch shmoop

01:11

well they're fund broker and gave them that awesome front

01:14

row said a seats at the n b a game

01:17

Last saturday night and well they didn't do the math

01:19

on just how much those tickets actually cost them over

01:22

the next twenty years is paid fees on mutual funds

01:26

broker sold them well we really don't know why people

01:29

invest in managed funds anymore it's pretty much a dying

01:32

industry today there's almost nobody ever in any five or

01:36

ten year period of time who after fees and taxes

01:40

beats index funds Why Well a bunch of reasons the

01:43

biggest is that funds have to fight hard for what's

01:46

called shelf space yet like in a grocery store but

01:49

it's in a stock brokerage to get sold through broker

01:52

channels or other places where people buy mutual funds and

01:56

that costs money so small funds get ignored and there's

01:59

always a lot of pressure for mutual funds to get

02:02

bigger so they can charge more fees and pay more

02:04

for distribution Well the best way to get bigger would

02:07

be to just have superior performance and let your numbers

02:10

do the talkin right Like michael phelps doesn't have to

02:13

pound his chest about how great a swimmer he is

02:15

right Why Well you can't see his chest it's covered

02:19

With a whole bunch of olympic gold medals there yeah

02:22

so funds spend a lot of resource is trying to

02:26

get bigger marketing wise rather than better investing wise and

02:32

they do try to be better They're sincere they work

02:34

hard They all want to be one flavor or another

02:37

of the michael jordan of investing who's named warren buffett

02:42

in real life Unfortunately for the mutual fund industry however

02:46

well they have all kinds of ugly headwinds in their

02:48

face One big headwind comes in the form that mutual

02:51

funds have to hold back a certain amount of cash

02:54

because well just in the wrong time Retail investors like

03:00

you know mon pa kettle well they redeem their mutual

03:03

fund shares I'ii sell them and they put the money

03:06

in the mattress Historically most mutual fund redemptions come near

03:10

the bottom of these ugly bear markets right at the

03:13

time when investors really will have wanted to start investing

03:16

or then getting them exposed to mutual funds and high

03:19

risk rather than taking all the risk off the table

03:23

So mutual funds always have to carry a meaningful amount

03:26

of cash like five or ten percent in case those

03:29

redemption suddenly hit but if you step back a little

03:32

bit lou that's too far there that's better Alright well

03:36

overtime markets go up on average growth index is go

03:40

up eight to ten percent a year So with dividends

03:43

reinvested over long periods of time so just the fact

03:47

that a mutual fund might need to keep say ten

03:49

percent cash in a world going up but ten percent

03:53

of years to get the math easy here Well that

03:55

mutual fund by being required to carry cash is losing

03:59

one percent a year in performance and that's just the

04:02

g rated problem The pg thirteen problem is that mutual

04:05

funds are relatively expensive A typical index fund might charge

04:10

half a percent a year to manage your money or

04:12

a whole lot last The big ones like spy charge

04:15

more like point two percent And just so we're sure

04:18

you have the decimals Right That is for each hundred

04:20

dollars you invest in spy run by vanguard You pay

04:24

twenty cents a year right Like a little less than

04:27

two cents a month for managing your hundred bucks Pretty

04:30

cheap and analogous Mutual fund would cost one hundred basis

04:33

Points more than that i e one percentage point or

04:37

more like two percent three percent and many mutual funds

04:40

carry up front loads or commissions paid to the broker

04:43

who got you those nice and tickets what's the most

04:46

species mutual funds market themselves as no load funds which

04:51

is a complete darth vader resc joke Darth doesn't tell

04:56

jug so this is no joke either so we're dividing

04:59

load with commission and no load funds Well no load

05:03

means roughly this Instead of charging you a load to

05:07

get into the fund we're going to charge you one

05:09

and a half percent a year for managing your money

05:12

forever So do the math If you remain to fund

05:15

holder for twenty years from attacks perspective it's very expensive

05:19

to ever sell a fund more on this soon In

05:21

more videos you'd have paid one point five percent in

05:24

fees for twenty years and the fees or set based

05:27

on the amount of money you have So as the

05:29

market goes up and the value of your investment goes

05:32

up while you get charged mohr generally speaking meaning that

05:36

if you started with ten grand and were charged one

05:38

hundred fifty bucks a year to manage that money Well

05:41

when it doubled to twenty thousand dollars eight years later

05:44

you're charged three hundred dollars a year to manage it

05:47

Why when it doubles again forty thousand eight years later

05:49

and here your charge six hundred dollars to manage it

05:52

and that fund might have the exact same basket of

05:54

stocks which all went up about the same amount here

05:57

after year but now it costs you six times as

06:00

much for the privilege of having those same stocks you

06:02

coulda bought yourself all right We'll compare this with a

06:04

load fund load funds charge Ah hi fi if you

06:08

invest on ly very small amounts of money largely because

06:12

the paperwork and add wins expensive to manage but by

06:15

the time you're investing ten thousand dollars well loads are

06:19

usually pretty low like two ish percent but then the

06:22

annual fee is more like zero point seven percent So

06:25

if you do the math from above yes you get

06:27

hitting your one with that commission or load And yes

06:31

it cost you a relative bundle if you sell after

06:33

only a year or two but if you're like ninety

06:36

Eight percent of the world and hold your fund for

06:38

over five years in a very large percentage Hold it

06:41

over twenty years Well any of more than made back

06:45

the no load gimmick and then some Well But all

06:48

of this pales compared with the fees charged by index

06:51

funds which are almost entirely no lo and almost always

06:55

way last than half the annual fee of manage funds

06:58

and so on But we're moving on here Here's the

07:00

r rated problem with managed funds versus unmanaged funds taxes

07:06

managed funds manage That means they buy and sell stocks

07:10

They sell the winners and they buy the losers While

07:13

each time of fund recognizes a gang sells an investment

07:17

for a profit the fund shareholder gets taxed Let's make

07:21

up a prototypical fund here it realizes gains in two

07:24

ways Short term and long term well short term gains

07:28

are gains garnered inside of one year long term means

07:32

they held the investment over a year and then sold

07:35

it you The shareholder in the fund gets taxed both

07:38

ways as well of course and short term gains generally

07:41

must be distributed back out to shareholders in the form

07:44

Of an annual gain on which investors ben pay ordinary

07:47

income tax so for fund is twenty percent of their

07:50

gains realized and they are short term gains in a

07:53

typical investor pays thirty five percent marginal tax on that

07:56

game Which berries on your region I it'll be more

07:59

in california new york and less in wyoming taxes are

08:02

a big headwind managed funds have you got all this

08:05

together and you have a one percent headwind from having

08:08

hold cash Another fee headwind of another center too Got

08:12

a whole lot of realized gain headwinds from taxes and

08:15

all that stuff Well then yes index funds and etfs

08:18

which are very similar Well they do realize gains every

08:21

now and then but they realize that very small for

08:23

action of the gains that mutual funds realized because index

08:26

funds and e t s realized gains simply to re

08:29

balance the portfolio not to make investing beds all right

08:33

And lastly empirically there's almost no difference from manage funds

08:38

and index funds in actual performance that is manage funds

08:43

don't beat the market In fact most index funds outperformed

08:47

managed funds almost any way you slice and dice the

08:50

data So ah market alfa or market intelligence well just

08:55

doesn't exist anymore certainly not the way it did in

08:57

the nineteen sixties Anyway those were all the r rated

09:00

investment fee situations you just have to know about But

09:03

now how about some triple x Alright hey hold your 00:09:06.962 --> [endTime] horses This isn't shmoop after dark

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