Costs Limit Your Investment Returns

Here's a piece from USA Today that talks about the role costs play in your investment returns. The short summary: costs may seem minor, but they can add up, especially when compounded over time, and can significantly impact your investment performance. And the worst part -- if you don't pay attention to them, you'll never notice them at all -- they simply eat away at your return silently:

You don't get a bill from your fund company every year. In fact, the fee doesn't come directly out of your pocket. Instead, the fees are taken from the income or assets of the fund, says Linda Wolohan, spokeswoman for Vanguard Group, which offers funds and ETFs with some of the lowest fees in the industry.

The piece goes on to praise Vanguard again:

Last year, the average fee charged by the mutual fund industry was 1.22%, Wolohan says. That would be $1,220 on a $100,000 portfolio. Vanguard funds, on the other hand, had an average expense ratio of 0.2%, or $200 on the same $100,000. Over the years, that difference mounts, especially when subject to compounding.

The fact that costs matter in investment returns is one reason I like index funds. They keep costs (expenses, fees, taxes, etc.) low and thus deliver a superior return after expenses than most other options.

Let's look at the example expenses above. One has an expense ratio of 1.22% and the other has one of 0.2%. Let's assume the following:

• The more expensive fund out-performs the inexpensive option on a before-expense basis -- so much so that the difference between the two is only 0.5% instead of 1.02%.

• For purposes of illustration, we'll assume the after-expense return of the first option is 8.5% while the second one brings home 9.0%.

So, what's that mean to us money-wise? If a person were to invest $5,000 per year in the lesser expensive option for 40 years, he'd end up with $211,000 more. And yes, before someone says it, I'll point out that $211,000 won't be worth $211k in 40 years due to inflation. Still, it would be better to have it than not have it, wouldn't it? Especially if it's a gain simply because you watched your expenses. Seems like an easy way to earn a bunch of extra money to me.

Comments

[mrm]

Wow, a Vanguard spokeswoman sourced in an article praising Vanguard...go figure...

[FMF]

mrm --

Are you disputing the facts? (that costs make a difference and that Vanguard has low cost funds) Or are you just being cranky?

[Adam]

I think if you actually did a fund-by-fund comparison for an actively (well) managed fund verses and index fund, you'll find there is a significantly larger rate of return difference between the two. That's the whole point. Do your research to see which fund managers have been doing well and you will consistantly beat the index fund returns...buy much more than a half percent. In my experience, the worse case scenario is breaking even when considering the expense ratios.

[FMF]

Adam --

"In my experience, the worse case scenario is breaking even when considering the expense ratios."

THis flies in the face of reems of data -- not just from Vanguard -- saying the opposite.

[mrm]

Just being cranky...no fact disputing here :)