Fees Are Only Part of the Investing Story

The most important thing I learned in my investing career is that, "Every security, every industry and every market can go to zero." With this in mind, I am always attentive to risk, not volatility. MPT is all about moderating volatility to accommodate a person's psychology to accept wide swings in asset prices. Managing risk requires one to understand an asset and its value. Volatility to a true asset manager merely creates opportunity.

The wealthiest investors today are investing with hedge funds, private equity and venture capital. Many of these investments charge what would seem to be outrageous fees of 2%, plus 20% of profits over net 5%. Even Warren Buffett hired two former hedge fund managers to potentially take over the Berkshire portfolio long-term. Why did he not just place the funds in a MPT risk allocation using cheap index funds?

The simplest way I can explain when and how to use an index fund versus an active fund is as follows: Use an index fund when you feel comfortable long term in an asset class you desire to own over a five-year-plus time frame and you don't have the expertise to pick specific securities. If you feel the large-cap multinational U.S. companies are a great long-term value and you intend to buy them, you are probably best suited to buy an S&P 500 index fund. Use an active U.S. managed fund when you are not sure what to own domestically but you like the U.S. long term. Use an actively managed worldwide fund if you want to be invested but are not sure what or where in the world to buy. Use an index fund if you know you want developed-world stocks or solely emerging-market stocks. There is also nothing wrong with buying individual stocks if you have the time and talent to analyze companies.

MPT worked great in a 30-year bull market of stocks and bonds. The "Dogs of the Dow" theory worked for many years until it became too popular. There are many in the advisory community who believe low-cost funds in an MPT allocation model is the way to go, but remember that every investment can go to zero. Make sure you and/or your adviser are well aware of that.

Sometimes you want to pay high fees for real talent and sometimes you want to pay the lowest fee possible for exposure to a great asset class. Fees are only part of the story.