Low Costs Usually Equal a Better Investment (And the Various Costs You Need to Look For)

I've noted before that costs matter if you want to maximize investment returns. In fact, this is one reason I like (and use) index funds as a major part of my portfolio. They keep expenses down which helps to keep my returns up. It's a great deal all around. ;-)

Recently, Yahoo columnist Laura Rowley detailed the impact costs can have on investment performance. She started out comparing two different funds and how they performed based on their associated expenses. The funds:

Fund A

• Annual return before expenses: 10 percent
• Annual operating expenses: 1.5 percent 
• Value of investment in 20 years: $49,725 

Fund B

• Annual return before expenses: 10 percent
• Annual operating expenses: 0.5 percent
• Value of investment in 20 years: $60,858

And here's a summary of how they performed:

Choosing Fund B would give an investor 18 percent more money over the 20-year period.

Rowley then goes on to detail what she calls the "big three" investment expenses. They are as follows:

1. Expense ratio. This represents the fund's total annual operating expenses (including management fees and other expenses), expressed as a percentage of average net assets. If a fund with $100 million in assets charges $1 million to manage the fund, that's an expense ratio of 1 percent.

2. Load or sales charges. This can be a front-end load, charged to pay a broker upfront when you buy the fund. Or you can get spanked with a back-end load when you sell the fund. There are also level loads that can be charged over a period of years.

3. Account management fees. These are charged to maintain your account, and sometimes levied if the value of your account falls below a certain dollar amount.

I would add taxes to this list as well, but taxes are as much under your control (what you invest in and how you invest) as they are the fund manager's, so maybe that's why she left them off.

Rowley's list is basically a list of "why you should invest in index funds." They have low expense ratios, no sales charges or loads, and no account management fees (usually.) For further details, see Why I like Index Funds.

Finally, Rowley also points to Calculating Mutual Fund Fees and Expenses, an SEC page that gives some additional thoughts on mutual fund fees. This page, in turn, points to an NASD page that features a nice little expense calculator.

Comments

[Lord]

The fourth should be turnover. Those brokerage costs, slippage, gain realizations, add up but escape the management fee designation.