It pays to pay attention to stock fund fees
Price-conscious or not, consumers invariably slip from time to time. What’s the big deal if you buy something you want for $1.50 at a convenience store rather than spend $1 at a discounter?
It can seem that way with mutual fund expenses, although investments clearly aren’t impulse buys. Many investors give little thought to the impact of choosing a fund that charges 1.5 percent over another charging a 1 percent expense ratio.
Given that the stock market frequently moves a few percentage points in a single day, do those seemingly minor pricing differences really amount to much over the long run?
They sure can — to the tune of tens of thousands of dollars, over decades.
How modest fees add up
Take for example, the growth of a $10,000 investment in a stock fund over 30 years, if the market gains an average 10 percent a year. (Although that rate may seem unlikely given recent experience, it’s close to the market’s historical average going back several decades.)
An investor paying 1.5 percent of assets in annual expenses ends up with nearly $116,000. That doesn’t factor in inflation or the potential drain of commissions known as loads and taxes. The same investment in a fund charging 1 percent grows to nearly $133,000.
Those two expense ratios — the ongoing charges that investors pay for operating costs, expressed as a percentage of a fund’s assets — are about average for managed stock mutual funds. Go to the extremes, and expense differences have a far bigger impact.
An investor in a pricey fund charging 2.5 percent ends up with less than $88,000. An ultra low cost index fund charging 0.1 percent comes away with almost twice as much, nearly $170,000.
And while there’s no controlling the market’s direction, individuals can control how much they pay to invest. So take charge.
“Cost is the driving force in any investment equation — minimize it,” advised John Bogle, founder of the Vanguard Group and index mutual fund pioneer who now runs Vanguard’s Bogle Financial Markets Research Center.
There are, of course, many examples of fund managers whose investment-picking skills earn their investors bigger returns than their benchmark indexes. But a wealth of research shows the ranks of such star managers are relatively small. And their record of outperformance is typically fleeting, measured against the decades needed to save for retirement.
“It’s clear that over longer stretches, costs are a big, big hurdle,” said Karen Dolan, Morningstar’s director of fund analysis.
From 2005 through March 2010, U.S. stock funds charging the lowest fees posted average annualized returns that were nearly two-thirds higher than funds charging the highest fees, according to Morningstar.
More often than not, funds charging above-average fees are leaky faucets. Many investors fail to hear the drip-drip-drip that drains their investment returns, when they could be switching to a lower-cost option.
Fees matter more in tough times
There are times when differences in fund expenses don’t seem to matter much. Stocks surged in the 1980s and `90s, and fee differences were relatively small stacked up against the big market gains.
But the Standard & Poor’s 500 stock index is down about 17 percent since January 2000. Fees take on greater importance when returns are measured in single digits, or when stocks are declining.
The same is true now for bond funds. Yields are so low for many lower-risk bond categories these days that minor differences in bond fund expenses are magnified — 10-year Treasurys are yielding about 1.9 percent now, for example.
But there’s good news. Fund fees on average have been declining for decades, and the trend is likely to continue.
A Morningstar study that gauged what the average fund investor pays came up with an average expense ratio of 0.77 percent in 2010. That reflected a mix of assets in stock funds as well as bond funds. In 1990, the average was 0.94 percent.
Costs are declining, in part, because index funds are increasingly popular. They now hold about one of every seven dollars invested in stock mutual funds, and the proportion is growing.
Low-cost options abound. For example, Vanguard’s Total Stock Market Index Fund (VTSAX) charges as little as 0.07 percent — $7 a year for every $10,000 invested. Similar offerings from Fidelity and Charles Schwab charge only slightly more.
You won’t beat the market — index funds seek to match market performance, minus the fees they charge — but you could end up with a lot more to live on in retirement than from choosing a fund that’s far pricier.
“More often than not,” Lipper fund analyst Tom Roseen said, “it’s the investor in the fund with the lowest expenses who ends up the winner.”