We spent part of last weekend looking for replacements for our old washer and dryer, which definitely were on their last legs. In doing a bit of research before heading for the appliance store, I found an unexpected parallel with investing.
I won’t try to stretch the analogy too far, but with both funds and appliances it’s easy to get attracted to bells and whistles. And in both categories, it’s important to look at operating costs.
On the bells and whistles front, it’s amazing how high-tech laundry appliances have gotten. We focused on features that we were sure we would use, which narrowed the field by eliminating some of the more gee-whiz machines, but also some of the most basic models. We decided to stick with basic white exteriors, given that it was nearly $100 more per machine to get snazzy red or blue paint jobs.
With investments, bells and whistles—or complexity, to put it another way—can be a costly distraction, too. Diversification is vital—because it helps the investor deal with the volatility of stock and bond prices and lessens the risk of loss from individual securities. But complexity isn’t required to be well-diversified. You can own funds based on broad market indexes, rather than a dozen funds covering every market sector. Funds based on broad market indexes can give extremely wide diversification without being overly complex for the investor. The more complex an individual’s portfolio, the greater the effort to monitor and adjust the holdings for tax purposes or when rebalancing.
When it came to a washer and dryer, a key factor for us was ongoing operating costs. By paying more upfront, you get significant savings in the amount of water and electricity per load of laundry. Given the long life of these appliances, and the strong likelihood of higher water and electricity rates over the years, getting efficient machines seemed sound. It also felt good knowing we’d reduce the environmental impact of cleaning socks and shirts and such by using less water and power.
And, of course, cost matters in investing, too. Over the long haul, low operating costs mean you keep more of whatever your portfolio earns. David Kiley, a senior BusinessWeek correspondent, wrote recently about his family’s personal “Recovery and Reinvestment Act,” which involved both cost reduction in his investment portfolio and the plugging of what he called “household budget leakage.”
It won’t surprise you that I think his focus on the operating costs of his investments is spot-on.
A reduction of 1 percentage point in annual expense ratios, roughly the savings Kiley experienced, amounts to $1,000 per year when applied to a $100,000 portfolio. At that rate, it doesn’t take long for the difference to surpass the cost of a new washer and dryer.
• All investing is subject to risk. Diversification does not ensure a profit or protect against a loss in a declining market.
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