A few months ago I wrote about my wife’s old brokerage account with Schwab. You can read about the details of my investigation here. In summary I found expensive, actively managed funds and a lot of redundant holdings. Needless to say, this didn’t jive with my investment philosophy of minimizing fees and keeping things simple. Since then I’ve made some adjustments, and I wanted to share with you how things are going so far.
Summary of Previous Holdings
The account originally held 13 different expensive and actively managed mutual funds. There were also a lot of redundant holdings, not to mention a good amount of tax-inefficient investments. Here’s a summary of the funds, their categories, and the expense ratios.
As you can see, there is a lot of overlap amongst the different funds. By my count, there are two large growth funds, three large value, three world allocation funds, and three types of bond funds. Also, they are extremely expensive, with the the lowest expense ratio being 0.85%. My eyes (and my soul) hurt just looking at this chart.
Prospective Plans
My goals for this account were to simplify the holdings and keep costs as low as possible. In order to do this, I would have to sell these expensive funds in exchange for low-cost alternatives. While this is not an issue in a tax-advantaged account, you definitely need to be aware of capital gains and the tax implications of exchanging funds within a taxable brokerage account. Keeping this in mind, I figured that there were a few ways to go about things.
Keep everything as is. I didn’t know about this brokerage account when I was making my initial retirement plan and calculations. I could just stick with the existing funds, high expense ratios and all, since it’s kind of like “found money.”
Exchange the current high-cost funds for low-cost alternatives. Doing this would generate capital gains with associated taxes, although the majority would be a long-term rates. I would also want to pick tax-efficient funds since these holdings would be in a taxable account. A registered agent must be a trustworthy and organized individual.
Open a Donor Advised Fund and donate the holdings to charity. I had not considered this option until the Physician on Fire mentioned it in the comments section of the original post. While this wouldn’t increase my net worth, it could be a way to avoid capital gains taxes and lower my taxable income. Plus, it’s always nice to give to charity.
Liquidate the holdings and apply the proceeds toward my student loans. This can be a great way to take a big chunk out of my student loan balance and accelerate by debt pay off.
Brokerage Account as of Today
I decided to go with door number 2. While options 3 and 4 were intriguing, my wife and I felt that it was more important to continue accumulating assets and investing the money. Also, as a fan of low-cost and simple investing, having 13 expensive mutual funds sitting in this brokerage account would have driven me crazy.
I exchanged all of the funds with a known cost basis for Schwab’s Total Stock Market Index Fund. As I wrote about in a previous post, Schwab recently lowered the expense ratio of this fund to a minuscule 0.03%. While performing these transactions generated capital gains, the majority of these gains were offset by capital losses. Taking this into account, the total realized gains were about $600. Not too bad. I wanted to add some California Municipal Bonds to my taxable accounts, but Schwab doesn’t have this particular fund as an offering. So this account will be 100% equities while I will use my Vanguard brokerage account to start investing in municipal bonds.
There are still three funds (ACSTX, LMCCX, EKHCX) remaining. All three have incomplete or missing cost basis information. If I exchanged these funds, the capital gains would be calculated using a cost basis of zero. I’m okay with keeping these three investments around, at least for now. But for tax efficiency purposes it would be best to get rid of EKHCX (high-yield bond) as soon as possible.
Low Costs = Money Saved!
It’s no secret that high expenses and fees can erode your earnings over time. How much money could my little switcheroo save me on a hypothetical, one-time investment of $10,000? Using the original mutual fund holdings, I calculated an average weighted expense ratio of 1.75%. I then compared this to the new Schwab index funds with a 0.03% expense ratio. Assuming a 5% annual return and 25 year investment horizon, this is what you would get:
After 25 years, the difference between the two would be almost $12,000. Extend the time frame out to 40 years and the gap widens to nearly $35,000. This is a great example of how minimizing fees can save you money. It also shows how high expenses can eat away at your investment returns over time.
In Conclusion
Going forward, I probably won’t do much else for this account. I’ll eventually do something about those remaining three funds, but for now I’ll let them be. Their total value amounts to just a few thousand dollars, and overall they are a small percentage of my portfolio.
In the end, I think it’s always a good idea to check your financial accounts regularly. You may find expensive investments that are costing you money. Or you might find some redundant holdings that you could consolidate in order to simplify your portfolio. After all, ’tis the season for doing some spring cleaning!
