My Mistakes: Here’s The First Mutual Fund I Ever Bought – And How It Cost Me $8,000

The whole point of Begin To Invest is to help pass on lessons I learned when I started investing to investors today.

 

Here was one of my first and most painful.

 

In 2007 I was just opening up my investment account and beginning to invest. Initially I had just opened up a regular brokerage account (Instead of something like a ROTH IRA, which was mistake #1, but that is not the topic of this post…We’ll save that for lesson #2).

I had received a couple thousand dollars from my grandparents and had saved from working summer jobs and also received some money from my parents to get started investing. I split about $4,000 into 2 different mutual funds.

 

One of those mutual funds turned out to be a terrible mistake that still haunts me to this day.

 

The Nightmare Begins

 

That mutual fund was ADVDX – Alpine Dynamic Dividend Fund

I don’t recall exactly what initially attracted me to ADVDX (There is the first sign it was probably a bad investment – I don’t know why I bought it!). It most likely had to do with the dividend yield, which we are about to see is a terrible reason to make an investment unless you absolutely need the income to live on.

 

In May 2007 I bought roughly $2,000 in ADVDX for $13.62 a share (~147 shares). I set all dividends to reinvest into new shares of ADVDX.

Time goes by, and as I started to make an initiative to learn more about investing I realize what a mistake I had made.

In June 2011 I sold about 300 shares for $4.71 a share, for a total of $1,413.

 

That’s a $600 loss, or about twice what I would have lost if I would have just invested in the S&P 500.

 

I traded ADVDX for an ETF run by Vanguard, ticker symbol VIG – Vanguard’s Dividend Appreciation Index ETF.

 

Here is a chart on how these two investments have fared over time:

 

ADVDX vs VIG

 

An equal investment in VIG in 2007 would have actually resulted in a gain of about $2 a share factoring in dividends over the same period I lost $600 in ADVDX.

 

Now this isn’t just a “Shoulda, Coulda, Woulda” post. There are some very fundamental reasons why VIG was (and still is) far superior to ADVDX. For an idea why, here are some basic facts of each fund.

 

ADVDX   VIG
Expense Ratio

1.28%

0.10%

Turnover Ratio

258%

14.90%

 

 

Why are these two numbers important?

 

Expense Ratio

The funds’ expense ratio tell investors how much of your money the managers of the funds take for themselves every year. The 1.18% expense ratio difference meant that there was little to no chance that over a long period of time I could even meet the performance of the general market.

One of my favorite images comes from the Wall Street Journal, and it shows how a fund’s expense ratio can really add up over time.

Expense Ratio add up

 

ADVDX’s expense ratio is 1.18% higher than VIG’s! So multiply the numbers above by more than 10x. It is truly staggering!

 

 

Turnover Ratio

The fund’s turnover ratio reflects how active the managers of the fund are. A turnover ratio of 258% means that the percentage of the fund’s assets that have been sold and traded for other assets. A turnover ratio of 258% means that the average asset is only held by the fund for less than 4 months.

The aim of ADVDX is to generate dividend income from buying stocks offering special dividends, so the turnover ratio is understandable. But what investors need to know is that a high turnover ratio means high fees that the funds have to pay their brokers and therefore higher fees the fund charges you. As ADVDX explains in their prospectus, these fees generated from trading are not factored into the expense ratio. This means investors face yet ANOTHER fee by this high turnover ratio.

 

 

All these fees that investors pay means that the fund managers must technically now OUTPERFORM their benchmark in order to deliver the benchmark’s returns.

If the market returns 5% this year, you can get a 4.95% return if you invest in an S&P 500 index fund with an expense ratio of 0.05%.

If you are in a fund that charges 1.25% expense ratio per year, you will get a return of 3.75%. In order to get a 5% return, the fund’ managers must really return 6.25% before expenses!

Study after study has shown that there is an inverse correlation to a fund’s performance and its expenses. Shown below is a figure from a research paper from Vanguard, which can be found here:

https://pressroom.vanguard.com/nonindexed/3.31.2013_The_Case_for_index_fund_investing.pdf

 

Vanguard expenses and performance correlation 630px

 

So when a fund has a very high turnover ratio, you need to seriously scrutinize the fund’s past performance and future prospects. A high turnover ratio means higher expenses that you have to pay, and higher return the managers will have to receive just to break even.

 

The Real Loss

Initially just looking at a $600 loss doesn’t really seem like a big deal in the grand scheme of retirement. But where early investment mistakes really hurt you are the loss of compounding interest you lose from that early loss.

 

Below is a chart showing the long term appreciation of 2 scenarios; In green is if I would have invested in VIG from day one. In blue is the result of investing in ADVDX for 4 years then switching over to VIG (which I did).  After year 4, both investments are returning the same amount, 6%, but the blue line had much more significant losses in the first 4 years.

VIG instead of ADVDX

 

In other words, that “$600” lesson for me was really something closer to $8,000!

 

 

Conclusion

 

So what are the lessons from my mistake?

  • High expenses generally mean lower returns.
    • Lower returns mean you have less money.
      • Having less money means you have less effects from your investments compounding over time.

 

So how important is that first investment of yours?

Because of compounding interest it may be one of the most important investing decisions you make!

 

Even though today I invest much more than $2,000 per year, I have yet to make an $8,000 mistake.

 

Hopefully my loss can be your gain.

 

Thankfully, I changed when I did. A quick little back of the envelope calculation says that if I would have stayed in ADVX until today, the long term cost would be more like $20,000! So it is never too late to get on the right track!

Similar Posts

One Comment

Leave a Reply

Your email address will not be published. Required fields are marked *