When Not Knowing is Expensive

Many of you have heard the saying “You don’t know what you don’t know,” especially if you’ve read my newsletters for a while or attended my informational workshops. This doesn’t mean you need to know everything! For most people it would be costly and/or impossible to go through life trying to do everything yourself. However, if you don’t know something, then it is a tremendous benefit to have someone on your team who does know. When it comes to your investments, this benefits you because the person in the know saves you money by seeking value.

I’ve written and spoken about the cost difference between “retail” mutual fund share classes (which an individual investor can purchase) and institutional mutual fund share classes (which institutional investors, like PCA have access to). There are larger firms than PCA, which may not always provide their clients with the best share class of mutual fund in their portfolios. This can add cost, without adding value, to the client which is not easily understood.

I want to give you another example of investing cost which is not easily understood. Some people invest in individual stocks or exchange-traded funds (ETFs), as opposed to mutual funds, solely because of lower internal expenses. It is generally true that mutual funds have higher internal expenses than ETFs and there are no internal expenses to hold on to with individual stocks. However, ETFs and stocks have a cost that mutual funds do not have. This cost is referred to the bid-ask spread.

If you are buying a stock or ETF, then you may buy for the “ask” price. If you are selling a stock or ETF, then you are selling for the “bid” price. There can be a significant gap between what you pay to buy versus what you would receive to sell, even if the stock or ETF price doesn’t change! This bid-ask spread can be 2 percent or more. Additionally, you may not have access to the best pricing. Some firms make money on this bid-ask spread when they use their own trading desk. At PCA, we do not receive any revenue based on the bid-ask spread our clients receive. The U.S. stock market has three tiers of quotes: Level 1, Level 2 and Level 3.

Level 1 quotes may provide retail investors with the highest “ask” price (what you must pay to buy) and the lowest “bid” prices (what you receive if you sell) for an individual stock or ETF.

Level 2 quotes provide additional information to identify the stock or ETF “market maker” with lower bid-ask spreads, which is important for larger investors who conduct high volume and high frequency trades.

Level 3 quotes are reserved for Institutional investors, registered brokers and financial institutions and provide the most favorable bid-ask spread available. As an investor, you want access to Level 3 trading, which we provide at Poterack Capital Advisory on our T.D. Ameritrade platform.

Many do-it-yourself (DIY) investors believe they save money by not working with a professional. There are some financial professionals that do not add value. However, higher internal expenses due to retail share classes coupled with costlier bid-ask spreads can cause DIY investors to lose money they don’t know they are losing!

When you work with PCA, we are representing your best interests as a fiduciary. It is in our clients’ best interest to pay the least internal expenses and receive the most efficient bid-ask spread available. When we do select investments having higher internal expenses, it is purposeful because of the value we believe that security provides in our client’s portfolio or else we wouldn’t make that choice. We don’t profit from higher internal investment expenses as some firms do. You don’t want to always buy the cheapest of anything, but nobody wants to waste money without receiving value.

Our clients know I am compensated based on their investment account values and not through commission-based trading or internal expenses. We are seeking value for our clients at PCA. Therefore, all expenses and bid-ask spreads matter as well as performance to both me and my client!