Cost matters. It is especially true when it comes to investing. I always tell clients to control what we can. Markets will fluctuate but we know what the expense ratio of a fund will be at the beginning and end of the year. And if you know me, you know that I’m not a fan of choosing individual securities because of the additional risk. Plus, even the biggest and brightest minds can’t get it right all the time. So what should you be looking for and why should it matter?
Things to Look For
Morningstar.com provides a wealth of knowledge for mutual funds and exchange traded funds. Here you can type in a ticker symbol of a fund at the top and get some information like I have below. Below you will see 2 mutual funds that you might recognize from your 401k plan as they are both popular funds and can be purchased in any type of investment account. I am only utilizing them as an example of cost and not recommending one over the other. The first fund is the Vanguard 500 Index fund which is an index fund that will track the S&P 500. The fees associated with it is an expense of 0.17% as seen by the right arrow. Morningstar has categorized the fee level as low and is below the average fee of around 1.3%. There is no load associated with this fund. I will discuss what a sales load is with the next one.
The next fund is American Growth Fund of America and we see that the expense ratio is 0.70% which is still lower than the average expense ratio. It is higher than the Vanguard fund but what you are paying for with American Funds is for the managers to beat their index. The Vanguard funds objective is to track the benchmark.
Now let’s talk about loads. Different type of mutual funds have sales loads attached to them. It is a commission that your advisor will receive for the advice he/she is giving. There are different type of loads but I won’t bore you with the details. The American Fund has a front end load because it is an “A” share. I know this because the title of the fund will have the share class in it (American Funds Growth Fund of America “A”). This load is 5.75% which will be deducted from your initial purchase and any ongoing contributions. So if you invested $1,000 then the advisor would be paid $57.50 and you would be investing $942.50 instead of $1,000.
Why Expense Ratios Matter
Vanguard has a great tool to extrapolate what fees will do to your overall returns. What might not seem like a high expense actually is over a long period of time. Take a look at the comparison of both mutual funds with an initial investment of $10,000 and an annual return of 6% over different time periods. I’ve highlighted a 10 year period. Vanguard 500’s expense would have eroded $436.84 or 2.7% of the total value over a 10 year period. American Fund’s expense ratio would have eroded $1,723.60 or 10.8% of the total value over the same time period. This also does not include the initial sales load. As the years go up the expenses will continue to eat away at the overall funds value.
What might not seem like a lot does affect the portfolio especially over long periods of time. Financial advisors can add value to your investment picture but you should also be aware of what costs you will incur.
So, do the funds you own have high fees?