As many of you know, I'm a fan of index fund investing. One of the reasons I like index funds is that they have a great track record of good, solid investment returns. Much of these great results are driven by the fact that index funds have very low expenses. And, as we know, low costs mean higher returns (also see Expenses, Taxes and Size Matter in Choosing Bond Funds (And Stocks too!) and The Advantages of Index Funds for more information.)
I found an example of how much expenses can impact your investment returns and it's pretty significant. Check out this paragraph:
If Vanguard’s 0.18% fee is low and the category average is 1.27% you can bet that some funds are as far above the average as Vanguard is below the average. A fund with an expense ratio as high as 2.36% will cost $11.2 million dollars more over 50 years than the Vanguard fund. Instead of a $16.8 million dollar portfolio with a low fee structure, your investment will only grow to $5.6 million dollars because of the higher fund fees. Add a sales load on the front and you will be left with $5.1 million dollars. The $11.7 million that was lost to fees and forgone earnings are hidden expenses that are usually not perceptible as they are happening, but extrapolated over time they are huge.
They certainly are huge! And while most of you reading this post aren't investing in funds with a 2.36% expense ratio (at least I hope you aren't), you may have total investment expenses that average 2.36% (for instance, you use a planner who charges 1% of assets and he buys a fund for you with an expense ratio of 1.36%). Or even if your total expenses are "only" the average 1.27% -- that's still a large number compared to many other alternatives and you could be losing millions throughout your investing career.
Of course, you want to maximize total return, so an investment with a 2% expense ratio that has a return of 15% is better than an investment with a 0.2% expense ratio and a 10% return. The problem is, it's hard to find a mutual fund investment that consistently earns a high enough return to justify a big expense ratio.
Or think of it this way -- one investment starts out with 1% less in built-in costs than another. The one with higher expenses is at a disadvantage from the get-go -- you're down 1% before you even get out of the gate.
It's figures like these that keep me investing in index funds.