Low Cost Investing: The Best Way to Boost Your Investment Income

by Alexander Green, Chairman, Investment U
Friday, July 27, 2007: Issue #696

When it comes to increasing your stock market returns, there are a number of effective steps you can take.

• When you buy, you can stick to a proven long-term discipline, whether it’s growth oriented or value oriented.

 

• You can use trailing stops or other exit strategies to better time your sells.

 

• Or, failing these, you can turn the management of your equity portfolio over to someone with a history of beating the market, through both up and down cycles, by a significant margin.

But the fixed-income game is very different. If you want more yield, you’ve got to practice low cost investing.

Four Ways to Reduce Investing Cost

With the benchmark 10-year Treasury note currently yielding a modest 4.8%, it’s still tough times for conservative income investors. The easiest way to pocket more of the bond market’s yield is to trim Wall Street’s take.

There are a number of ways to do this.

You can open an account with Vanguard mutual funds. These funds have the lowest expenses – and therefore the highest yields – in the business. The reason is simple. Vanguard is owned by the fund investors themselves. That keeps expenses ultra-low.

There are also exchange-traded funds or ETFs. Earlier this year Barclays Global Investors launched eight more ETFs, bringing its bond lineup to 14 funds. These ETFs, which you can buy through your discount broker, charge modest expenses of .15% to .2% a year.

Vanguard Group is also launching four bond ETFs this year. According to The Wall Street Journal, “among those four mutual funds, the one with the poorest relative performance has whipped 73% of its competitors over the past 10 years – and the best has beaten 93%.”

Why? Because it’s hard for a bond fund manager to work magic in the investment-grade bond market. Managing a bond fund with a high expense ratio is like dragging an anchor when it comes to winning the performance race.

Another option is closed-end bond funds. These funds are actively managed. So they tend to have higher expenses than ETFs. However, many of them trade at double-digit discounts to their net asset values. Any time you can buy a dollar’s worth of assets for 90 cents or less, that’s a good thing.

Closed-end funds – and their relationships to net asset value – are listed in Barron’s each week and The Wall Street Journal each Monday. Or you can find the ones trading at a discount by using the “fund sorter” at www.etfconnect.com.

If you want to cut costs even more, you can cut out all commissions and expenses entirely by heading to www.treasurydirect.gov and buying newly issued Treasury bonds directly from Uncle Sam.

(Some of the big discount brokerages, like Charles Schwab and Fidelity, allow online customers to purchase newly issued Treasuries at no cost.)

Same Risk, Better Returns

Keeping your fixed-income expenses to a minimum should be one of the first things we learn in Investing 101. Yet few of us seem to be paying attention.

According to Morningstar, over half of all bond funds charge expenses of 1% or more. Yet 26% of all taxable-bond-fund money resides in these funds.

The outlook for these funds isn’t promising. Last year 73% of them had performance that ranked in the bottom half of their category.

That’s an awfully expensive lesson, especially when the solution is so clear.

If you want to increase your bond yields, you don’t have to increase your risk. Just cut your investment costs.

Good Investing,

Alex

Today’s Investment U Crib Sheet

Last week, Alex highlighted the Western Asset Global High Income Fund (NYSE: EHI) – a closed-end fund that yields a healthy 8.4%. And you can buy the fund’s assets at a 12.9% discount, too. (Shares recently traded hands for $12.08, and Net Asset Value is $13.88.)

In other news… It’s been a rocky week for equities – volatility is exceptionally high right now. (The VIX – the CBOE Volatility Index – hit its 52-week high yesterday.)

Still, there’s no way of knowing, with certainty, where the S&P will go from here

“Predicting what the market will do tomorrow, next week or over the next six to 12 months,” as Alex put it in his May column, “isn’t a particularly profitable exercise.”

But preparing your portfolio for a potential, or prolonged, downturn is always sound practice. Here are five ways to reduce your risk and improve your returns in the process.

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