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Fees Matter!
By JLP | February 5, 2008
Okay, we all know that investing involves fees. However, did you ever think about just how much you could spend in fees over a 20 or 30 year period? It’s probably a lot more than you think it is. Why? Because fees compound along with the growth of your investment. And, even in down years, you are still charged a managment fee.
To get an idea of just how big of a bite a managment fee can take out of an account, I put together a couple of graphics. The first one assumes a 20-year investment period of a $10,000 lump sum investment (not including mutual fund sales charges or loads). Each section of the graphic looks at a different annual rate of return along with different annual expenses. The returns were calculated by subtracting the annual management fee from the rate of return and using that number to get the growth factor. Then the growth factor was multiplied by the $10,000 lump sum to get the future value of the investment. Make sense? If not, the graphic should explain it:
Wow! A 3% management expense nearly ate up half of the growth of the investment! Granted, 3% is a very high expense ratio. I included it because some variable annuities charge that much per year if you get all their “bells and whistles.”
Anyway, if you thought that was bad, take a look at what happens over a 30-year period:
At the 3% expense ratio, the amount spent on management fees was actually MORE than the account was worth at the end of the 30-year period! For instance, take a look 10% ROR section of the last graphic. Assuming a 3% expense ratio, at the end of 30 years the account would be worth $76,123 but you would have spent over $98,000 in fees over the 30-year period. Compare that to the account with the .50% annual fee, which would have grown to over $152,000 over the same period. That’s quite a difference.
Bottom line: Fees matter. You’re not gonna get something for nothing, but there’s no reason to spend more than you have to.
More follow-ups to come…
Topics: Investing, Mutual Funds | 14 Comments »
February 5th, 2008 at 3:39 pm
While fees do matter, you also have to look at it in terms of a real world scenario. Virtually any respectable place where you research funds, the returns shown are net of fees. So when comparing apples to apples, or two similar funds, while the fee is important to consider, if the reported returns are identical, you made the same amount of money.
Of course, the higher the fees, the better the fund has to perform to beat its peers or benchmark, so that is more than enough of an argument to stick to low fee funds.
This is more applicable to ETFs and index funds since they truly are an apples to apples comparison and the lower the fee the better the return in almost every case. But when it comes to managed funds, there is a lot more to be concerned about when selecting a fund than worrying about a few basis points.
February 5th, 2008 at 6:38 pm
Yes fees matter quite a bit. Many fee based financial planners charge anywhere from .50% to 1.75% to invest your money into mutual funds. Add that to the fee the mutual funds charge and fees can quickly add up. Jeremy is right; compare rates of return net of fees. Actively managed mutual funds have to charge a fee in part to pay for the research they do. Morningstar provides a Stewardship grade for many funds, looking in part at expenses, manager incentives, board leadership and corporate culture. When I look at fund’s expenses I think it is important to look a little deeper to gain insight into how the money is being spent. Fees affect net performance, but expense ratio should only one of the many factors considered in the buying decision, unless you are just investing passively say in index funds.
February 5th, 2008 at 7:16 pm
Comparing net performance, after-the-fact tells you nothing useful. It already happened, and there is nothing at all to indicate that the same performance will continue. While some people like to believe that you can pick managers base on past performance, no one has ever been able to establish persistence in excess performance beyond random chance.
The only part of your net return that you have any control over is the fee. Control what you can.
February 5th, 2008 at 7:26 pm
I’m a real geek for this kind of chart, thanks for feeding my geekiness.
February 5th, 2008 at 8:25 pm
This chart is incredible JLP. The impact of these fees is huge. In Canada, where the average MER is higher than in the US, this chart becomes even more important. The difference between a 0.0 and 1.0 is drastic.
February 5th, 2008 at 8:39 pm
I have an elementary question. What do you consider a “reasonable” fee?
February 5th, 2008 at 11:00 pm
You want real world. Here’s an excellent calculator that shows you the effect fees will have on your mutual funds over any period of time. It digs down to a level you won’t find on the FINRA site or any other, it takes into consideration many of the hidden fees that are rarely quantified by these calculators. i.e. the cost of fund trading turnover, found only in the SAI
It’s free to use and a great way to see the dramatic effects of expenses and internal fees on your mutual funds.
Personalfund.com
February 5th, 2008 at 11:13 pm
Single Ma,
That’s a good question.
According to my SmartMoney Mutual Fund Screener here’s the average expenses for mutual funds:
Small-Cap – 1.45%
Mid-Cap – 1.38%
Large-Cap – 1.21%
Multi-Cap – 1.25%
Global/International – 1.46%
Emerging Markets – 1.75%
Hybrid – 1.30%
Taxable Bond – 0.95%
Municipal Bond – 0.93%
Index funds should be a lot lower than these averages.
February 6th, 2008 at 9:17 am
Great info. I try to relay this info to my co-workers as often as possible. If you want to see real fee abuse, take a look at the 403b marketplace. Abusive fees and surrender charges litter the market. To make matters worse, horrible annuity products are pushed by salesmen masquerading as objective fiduciaries! What a nightmare scenario. If you don’t believe do a little reading at http://www.403bwise.com
February 6th, 2008 at 1:00 pm
[...] All Financial Matters: Fees matter [...]
February 6th, 2008 at 4:14 pm
Thanks for backing everything up with raw data. I tell people all the time to watch their fees, and so many of them take in nonchalantly. Maybe this will help!
February 11th, 2008 at 4:44 am
[...] All Financial Matters says that fees matter when it comes to investing. [...]
February 20th, 2008 at 7:20 am
Jeremy spins the classic myth offered by the industry that siphons billions of dollars from the retirement savings accounts of hard working americans:
“But when it comes to managed funds, there is a lot more to be concerned about when selecting a fund than worrying about a few basis points.”
Believe this little tale at your peril. A few basis points my eye.
March 8th, 2008 at 9:43 pm
Fees are important, but charts like this mask the real issue and that is that most investors suck at investing. The Dalbar study shows this year after year. The average investor is lucky to beat inflation, much less the markets. They focus almost solely on finding the funds with the cheapest fees and then wonder why their investments are poor performers. Very few investors understand risk and what it really means to their portfolios.