Watch It! Fees Kill Investment Returns

Your fees destroy my returns, Buster!

“But ma’am, you get what you pay for.  Stop looking at our mutual fund fees.  Instead, look at our investment returns.    Returns are where the money is,” said the rep for my 401(k).

With clenched teeth, I resisted grabbing him by his Armani tie and saying, “Your fees will destroy my returns.”

“Ma’am!  Quit thinking about the fees for just a moment.  Let me show you our most successful funds,” he continued.

“Get out of my office.  Now.” (I really wanted to say that.)

But Boomer, I’m a grownup.

“Thanks for stopping by,” I smiled.  “I’ll be in touch.”

Bless his heart.

Why do fees kill investment returns?

Boomer, it is expensive for companies to run an actively managed mutual fund.  This expense is passed along to you.  Via fund management fees, you are generously paying the mutual fund manager’s salary.  You, tiny dancer, also generously pay the legion of adviser and researcher salaries hired to help the manager beat the market.  (None of these folks are working for peanuts.)

Fortunately, these management fees are readily disclosed when you buy a fund.

But not so plainly evident are the other costs you so generously pay.  

These are the legal, accounting, auditing, SEC-filing, and other administrative costs.  Also included are any funds sold to you by financial planners or brokers.

These fees go by a variety of names, including “indirect fees borne by the investor,” “operating fees,” etc.  They can be found deep within the fund’s prospectus.  The prospectus is thoughtfully written for you—in plain legalese.

Index funds have lower costs and fees than managed funds.  

This is not to say that passively managed funds, called index funds, don’t have costs as well.  They do.

They, too, have legal, accounting, auditing, and other assorted costs. But they are on a much smaller magnitude.  Unlike, say, an actively managed stock fund, whose portfolio manager aggressively buys and sells stocks in an effort to beat the market, passively managed funds are seeded with stocks that mirror the market.

(We discussed this process in the last post in this series.)

Index funds don’t need to hire the legions of advisers and researchers who are charged with beating the market.  Consequently, legions of accounting, auditing, and administrative staff are not needed to support the operation.  Instead, the passively managed fund is tweaked from time to time to ensure that the fund mimics the market.

As such, passively managed funds have lower expenses than do actively managed funds.  Fund expenses are expressed as a ratio of total fund costs to total fund assets.  That is, the fund’s expense ratio = total fund costs ÷ total fund assets.

How do I find these expense ratios and what do they really mean?

You can find the expense ratio for any fund you are interested in by looking at magazines, such as US News and World Report and Money.  These magazines commonly rate the performance of actively and passively managed funds and include their expense ratios.

Isn’t that thoughtful?

Bless their hearts.

Boomer, I don’t know about you, but I just can’t divine the true impact of an expense ratio of 0.67% vs. one of 0.75%.  I mean is 8/100^th of 1% all that significant?

As a matter of fact:  yes. 

Help is on the way.

In my next post in this series, we’ll discuss the super hero agency that shows just how much these fees kill your wallet.  Stay tuned.

In the meantime, don’t forget:  fees kill investment returns.

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