Risk Controlled Portfolios

Controlling Expenses

Spending and expenses play a role in investment success as well.

Particularly for institutional investors and retired individuals, spending rates need to be taken into account when determining the amount of risk and return you seek. On the one hand, excess risk seeking a high return can lead not only to larger potential negative outcomes, but also to more volatile returns. On the other hand, lower returns from less volatile investments may not keep pace with inflation and investors’ spending requirements.

PMA founding partner Dr. Marshall E. Blume has published a study “Endowment Spending in Volatile Markets: What Should Fiduciaries Do?” that addresses the question of spending rates and investment returns. The Executive Summary is available here and the full article is available here.

Understanding the underlying expenses in your portfolio is another way of controlling risk. In fact, manager expense ratios have been found to be predictive of investment success. In an August 2010 study of mutual fund managers ranked by expense, Morningstar Advisor found that the least expensive 20% out-performed the most expensive 20% in every asset class and in every period, as illustrated in the chart below.

Controlling Expenses - Slide 3

Morningstar data derived from Russel Kinnel, “How Expense Ratios and Star Ratings Predict Success”, Morningstar Advisor, August 10, 2010.