In January of this year, Jason Zweig of the Wall Street Journal wrote about the trend toward zero management fees among several large mutual fund and ETF managers such as BlackRock and Vanguard.  Since that article was published, there have been many other articles and posts discussing the phenomenon of plunging investing expenses.  Given the ubiquity of material on this topic, it is not the purpose of this post to discuss what has already been dissected many times over.  Rather, it is to put the current state of low investment expenses into perspective because I think that, in order to appreciate fully this development, it is first necessary to understand just how high investment costs were even as recently as twenty and thirty years ago, and to consider what implications plunging investment costs may have for markets and investors.

A good example of the secular decline in investment expenses is Vanguard, a fund company mostly known for its fleet of low-cost, index-tracking mutual funds.  Forty years ago when Vanguard’s flagship S&P 500 tracking fund made its debut, the average expense ratio for Vanguard’s funds was around 1% of assets, according to The Economist.  Five years later, in 1980, the average expense ratio had fallen to around .60%.  Currently, Vanguard’s funds have an average expense ratio of less than .20%, a fraction of their original costs:

Investment Costs

Vanguard, of course, is not unique in that its management fees have declined steadily over the years.  A 2015 study by Morningstar, Inc. concluded that asset-weighted expense ratios have largely declined across the board:

Investment Costs

Investment Costs

[drizzle]But declining mutual fund expenses do not tell the whole story.  In fact, perhaps what is most telling is the huge decline in investment transaction costs over the years.  The result of several factors such as the advent of the internet and online trading, as well as the shift from fractional to decimal pricing on the exchanges, the steep reduction in transaction costs has been truly breathtaking.  Consider this Charles Schwab trading commission schedule from 1988:

Investment Costs

To put this in perspective, a Charles Schwab investor who in 1988 wanted to duplicate a $300,000 equal-weight portfolio of the thirty Dow Jones Industrial Average stocks would have had to pay roughly $2,970 in transaction costs, or about 1% of the portfolio.  It is worth noting that Charles Schwab was touting their commissions as “low.”

In stark contrast, today’s Charles Schwab investors can implement the same portfolio for as little as $8.95 per trade, or roughly $270.  Alternatively, they could replicate the performance of the Dow Jones Industrial Average by buying the SPDR DJIA ETF, $DIA, for the same low $8.95, and pay an annual net expense of .17%, for a total first year cost of about $520.  Essentially, today’s investor would be invested for about six years before he incurred as much in expenses as his father or mother might have thirty years before. It goes without saying that this illustration does not even consider the reinvestment of dividends, for which I believe Charles Schwab currently charges no fees.  It is probably safe to assume that this would not have been a cost-free option in 1988.

There are certainly many implications from this huge decline in investment expenses.  Low investment costs, combined with the current favorable tax treatment of equities, may mean that equity valuations will remain elevated longer than many historical models that focus only on earnings and revenues justify.  As a result, even if equity valuations are elevated relative to history, the implications may not be as great as some think, given that investors’ net returns (that is, after taxes and expenses) may be similar to those in the past, even if their gross returns are smaller.  As Ben Carlson put it a few months ago when he explored the same topic:

Investment Costs

However, there could also be negative effects to the low-cost nature of modern stock trading.  Data from the New York Stock Exchange show that turnover (the rate at which stocks are bought and sold) was 55% in 1988 when transaction costs were much higher, but slowly crept higher through 2003, though it is true that turnover has fallen off lately.

Another way to demonstrate this is through average holding period for stocks.  According to NYSE data, holding periods have steadily declined over the last 50 years as many investors have seemingly become short-term traders:

Investment Costs

In any case, it is likely that lower portfolio and investment costs are here to stay, and they are undoubtedly a tremendous benefit to modern investors.  In fact, given these developments, there is really no excuse why anyone with an interest in it should not be investing.

For further reading:

Trading Costs & The New Market Averages – A Wealth of Common Sense

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