On the money: why taxes matter

Why taxes really matter by Eric Balchunas, Bloomberg Intelligence (November 8, 2023)

Taxes matter more than you think. Over the long term, the difference of a few basis points can turn into real, big money. In this episode, Bloomberg Intelligence ETF analyst Eric Balchunas joins us to discuss how fees can significantly impact your portfolio.

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About this week’s guest:

Eric Balchunas was an ETF analyst for Bloomberg Intelligence. He has been covering the investment industry for nearly 2 decades. His 2016 article “How the Vanguard Effect Adds Up to $1 Trillion” shocked the investment community. He is the author of The Bogle Effect: How John Bogle and Vanguard Turned Wall Street Inside Out and Saved Investors Trillions.

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Transcription: Music: It’s the money that counts

Do the fund’s commissions reach 0? The trend in ETF prices has been lower fees. Now, after decades of falling prices, these taxes are approaching zero

Let’s bring in an expert to help us unpack this: Eric Balchunas, senior ETF analyst at Bloomberg Intelligence, has been writing about funds and ETFs for years. Eric what’s going on here is the taxes will go to zero?

Well, they’ve been going like this for a while, there are already some 0 fee ETFs that are from companies that aren’t as popular as Schwab or State Street, so I think once you get below 5 basis points, you’re to this very cheap kind of land where people don’t care you’re 3 or 4 you’re two or three you know everything is almost free basically

And for people who don’t talk in basis points, 1% is 100 basis points, so we’re talking about 3 basis points is 3% of 1%

So if you put $10,000 into the ETF with three basis points, it will be $3 a year

It’s crazy, it’s free

It’s crazy, it’s a beautiful thing, yes, that’s what I call the great cost migration, I call it the tax wars. That’s why I call the industry the ETF of Terrorism, because it’s brutal if you’re an issuer, everyone cuts fees. time but the thing is it works tax reduction is almost like hitting 1000 and if you do that the streams will come

So let’s put history back a little bit in 2016, you wrote a column titled The Vanguard Effect and the result was the fee pressure that the Vanguard Group was putting on Wall Street saved investors a trillion dollars explained.

If you say all the money that went to Vanguard if it was the finger didn’t exist right, a lot of that money is going to be in mutual funds that have an asset-weighted average fee of about 65 basis points; At an average fee, there is over 1%, but I would like to weight the assets to be fair, which basically says we are the majority of the assets, so 66

If that money were in an average Vanguard fund that charges Vanguard asset-weighted averages 9 basis points – that’s a huge savings, so the money moving there – if it wasn’t in Vanguard, we’d be paying 66 instead of nine, then Vanguard only has half. of passive assets, the other half are people who have copied them, so there are – Blackrock, State Street, Schwab, even JP Morgan and Goldman now have the Vanguard style, even Fidelity.

This was the best kind of teaching because fidelity was active manager but fidelity has cheaper index funds in Vanguard now and they advertise so that’s amazing so half the other half I owe to bogler Vanguard so that if you add all that up.” We’re looking at a trillion dollars in total, but that number is growing by about 150 billion a year, and that number is growing every year, so in the next decade or two we’re going to be looking at four or five actually savings from what Bogle and Vanguard did that

It’s unbelievable and let’s get this straight when Vanguard launched in 1974, mutual fund fees were like 2%, 1.86%, some crazy number like that, imagine there was almost no competition, fees were what they were, that is really half a century of tax pressure

When I talk about how investors respond to lower fees, it just so happened that Vanguard’s first index fund was priced at 66 basis points — right around the price of mutual funds on the cheaper side. And over time, no one cared at first because it was still crazy, but over time they kept reducing the fee because of the way their structure is.

So when they got into the 2000s, now they’re at 14, 15 basis points really cheap, then they got to 2008 2010, they go below 10 once you get into 10, you’re in an irresistible zone, people go Gaga for something which has the single digit basis point fee and why there have been no major studies showing that if you pay a few basis points over 30-40 years you get much more compounded return than the asset manager

Why does this matter, why do a few basic points here or there matter that can’t add up over decades, right?

So when Bogle was trying to sell the index fund, everyone thought ohh it’s average. I don’t want to be average, I didn’t work for a regular doctor, it was hard to sell an average to the American public, we want winners one chart he used, which was very convincing and I tell everyone, look, look here it is a graph of $10,000 growth / 50 years, one of them makes 8% per year and the other makes 6% per year, 2% would be fees you pay to the active fund plus turnover and trading costs, 8% would be paying no fees, no fees you’d get something like $300 and $60,000, 6% compounding only gives you $170,000 – basically double – and so when you put it in dollars and cents so over time it really matters and in other words it’s 8% that took 60% of your total return over those 50 years, so with no tax you basically get 98% something like that total. give back, because remember we’re all here for one reason.

Vanguard published a research paper some time ago that if you put $1,000,000 and let it compound over 30 years until the end of those 30 years, the feed difference is about 30%, so if you start with just 100 it’s double, but you know just speaking in percentage terms, it’s not insubstantial after two or three decades, yes absolutely, so the difference between paying 80 basis points versus 8 is major now, when we get to 8:00 to 7:00 it’s a little less significant that’s why I say we have to charge 0 ETF redemption fee I don’t really think once you get below 5

You’re good I don’t think people actually there’s almost a case where people sometimes reject from scratch they feel like it’s a trick maybe right and. So what we’ve found is if you look at advisor surveys, the top two criteria with them picking an ETF number one is fee #2 is a brand, so we tend to see money going to the big brands, let’s say Vanguard BlackRock for sure but also State Street and vesco Schwab these brands plus a small irresistible fee but if you take a brand Not known for this there was a company called focus shares the day they tried to undercut nobody she didn’t really care because no one knew the brand and she felt delusional, so I think the brand is also important here.

It’s not just the low fee, it’s the low fee, plus the brand, which is almost like an irresistible value proposition for most people, let me throw you a little bit off the curve, we’re talking about mutual funds and ETFs, but the reality is that it’s 2025. trillion dollars there’s another 50 trillion in equity and another 75 trillion in bonds, I don’t know behind that how meaningful ETFs and mutual funds are to how people manage their assets . if you do something more convenient, you’ll probably find some customers, so for me a mutual fund pushed the envelope to make it convenient if you give me your money and I’ll take care of buying all the stocks. diversification goes like this we don’t like it we don’t pick a stock and it goes to so we lose all our money we will diversify and I will manage it for you the problem is the structure of the mutual fund. it’s not nearly as efficient or there’s a multitude of reasons why the ETF structure, in my opinion, is a better vehicle to deliver what a mutual fund is trying to deliver, whether it’s active passive or whatever ETFs tend to be more efficient tax efficient, tend to be cheaper. you can get in and out then whenever you want mutual funds just once a day and they fit very well in the brokerage platforms that most people use and to me ETFs are kind of a vehicle for the 21st century that I often compared it. on MP3, while the mutual fund is kind of like an MP3 compact disc. I can’t right now buy the exact songs I want or if you’re streaming and you can add that flexibility if it’s on your phone better compact disc harder for you I know how to drag them around so I think every industry goes through this.

I would also say that an Uber to taxi is a different industry. Uber uses the internet, it’s cleaner than anybody, there’s always these disruptive events and so ETFs are big, but I have to say ETFs at 80 basis points wouldn’t be a big deal, I’m just very popular in sweeping the country because they are cheap and you have to give Vanguard and Bogle credit there, although he didn’t like ETFs

He had this monumental impact on it, so for me, whether it’s an index mutual fund or an ETF, the bigger trend is the high cost of migration and you have to go back and mess with that when it comes to getting investments in a local tax. format I think the ETF vehicle is the one most people prefer, thanks Eric, really interesting stuff, just unrelenting pressure on prices that has saved investors trillions of dollars, but more importantly we are aware of the impact of combining 10/20 /30 basis points makes a huge difference over time, especially if we’re talking decades and So what lower fees means is better long-term performance for investors you can listen to money every week , find him on our masters and business stream at the bloomberg.com Apple podcast and Spotify Tweet E will be here to discuss the issues that matter most to you as an investor

I’m Barry Ritholtz, who you heard on At The Money on Bloomberg Radio.