Beginning Online Investing

The main difference between traditional and Roth accounts is when the money you contribute is taxed.  For the traditional, your money is put in pre-tax and then taxed when withdrawn at retirement age.  The Roth account is the exact opposite.  Your contributions are taxed and then withdrawn tax free.  With tax rates remaining constant, the two accounts are esentially the same as seen below.

Contribution: $10,000

Current Tax Bracket: 15%

Retirement Tax Bracket: 15%

Avg Yearly Return: 10%

Years to Retirement: 40

Back in early 2006, I really wanted to get into the stock market.  I knew nothing, so I went to a financial adviser.  This happened to be an old friend of my parents from back in their college days.  I started a Roth IRA and a taxable investment account.  I went in, he helped me to start the accounts, told me what he recommended for mutual funds and and everything seemed fine and dandy.  I had my money in the stock market, just like I wanted.  

By the end of the year I had learned quite a bit about the stock market and mutual funds in general.  I have been reading many personal finance blogs (get rich slowly) religiously and started picking up on something called an expense ratio.  An expense ratio is measuring the total costs of a fund investment as a percentage of your monetary contribution. For example, if you put $1,000 into a fund where the expense ratio is 1.5%, you can expect that $15 be spent on manging the fund for the year.  This wont be subtracted from your account, but invisibly from the price of the fund.  This is how you pay the people who are buying and selling stocks in the mutual fund. This expense ratio is composed of other various fees also such as 12b-1 fees.

Now an expense ratio of a fund can be  good or bad depending on the fund(I will go into that in another post), but in general you want to avoid funds with high expense ratios(>1%) especially when investing for long periods of time (retirement).

Knowing how big of an effect expense ratios have on long term investments, I needed to know the expense ratio of the fund that I owned.  The fund I currently own in my Roth IRA is the Oppenheimer Port Series Equity Inv C (OCAIX). At the time, it had an expense ratio of somewhere around 1.5% (Now 1.86%!).   It also has a 1% deferred load if sold within a year of purchase.

When I found this out, I emailed my financial adviser asking him what was up with the high expense ratio.  I gave him the idea of using the ETF fund QQQQ in place of the Oppenheimer fund because it has a very low expense ratio.  (I realize now that the two funds aren't very similar at all in asset allocation, let alone one is an ETF and the other a mutual fund, but it is what I came up with at the time) He promptly replied, saying that he was glad that I was looking at expense ratios, and I was right to question it, but what I am paying for is the active management of the fund(which is true, and good as long as the managers can beat the market).  He said he would attach a graph to show how the funds compared.  Here is that image...

Now at first, you may think, wow, OCAIX is a great fund and the other really doesn't stack up (that is what I thought at the time).  If you are familiar with the stock market, however, or any sort of stock charting, this should stick out like a sore thumb. 

Now what he is telling me, and deceptively trying to show me is that the OCAIX fund has greatly outperformed the QQQQ ETF over the given period of time.  And he is right, if I would have put $1,000 in QQQQ in the late 90s and then $1000 in OCAIX at its inception in 2005, I would have had made a better return on the OCAIX investment.  This doesn't make any sense though. Why would I compare making two different investments about 6 years apart?  The market as a whole was in two totally different situations in the late 1990's and mid-year 2005.  It was working its way to the tip of a bubble in the late 1990s, while in the 2005 time frame when OCAIX came to birth, the market was beginning a bull run.  What he should have showed me was the following image.

In this image,  the return of an investment in the two funds over the same period of time is shown where both funds would have experienced the same market conditions.  Looks a lot different, huh?  The ETF actually out preformed the mutual fund by just under 10%.  I can't believe I fell for it at the time, but I did. I realize the two funds have different asset allocations so the performance difference is expected, but the fact that he tried to deceive me is what really makes me mad.

The OCAIX fund pays high 12b-1 fees which is like commission for selling certain funds.  These types of fees are what make most financial adviser's opinions and fund selection biased.  Kind of wish I would have payed more attention so I could have sent this as an email right back to him along with the papers for him to transfer my accounts to Vanguard.

I guess my advise is make sure you can actually trust your financial adviser.  Make sure he spends time explaining everything to you, but don't just eat up everything he says.  A lot of financial advisers are more salesman than anything.  Do some research for yourself,  read some blogs, and look into fee-based advisers for less biased advice.   After all, its your money.