The Impact of Mutual Fund Fees
A reader wrote in recently and recommended the website of the Texas State Securities Board to me. Unlike most stuff out there, it is relatively unbiased. He recommended a compound interest calculator (which is nothing special if you know how to use excel or a financial calculator.) But also a calculator which demonstrates the impact of mutual fund expenses, including loads, on your investment returns.
You’ve read on this site before that you should pretty much never buy a mutual fund with a load. Not only do the loads reduce your investment return, they also usually come with higher expense ratios, which further reduce your return. This wouldn’t be so bad if the funds were better than no-load funds, but they almost never are. So you’re paying more for a crappier product. Curious how much more? Let’s take a look at the calculator.
Let’s say you have $100K to invest. You’ll leave the money there for 30 years before withdrawing it. Your choices are an actively managed mutual fund that returns, let’s be generous here and say 7.5% before expenses over that time period and an index fund which returns 8% before expenses over that same time period. Let’s also be generous to that actively managed fund and pretend it actually continues to exist for the full 30 years. The index fund has an expense ratio (ER) of 0.07% and the actively managed fund has an ER of 1.5%. It also comes with a front-load of 6%. What’s the difference after 30 years?
- Loaded, high expense, actively managed fund: $522,960
- Index fund: $985,347
- Difference: $462,387
Now I don’t know about you, but that seems like a lot of money to me. The calculator says that for the actively managed fund you lost $6K to the commission, $117K to the operating expenses ($8K for the index fund), and $235K in opportunity costs ($12K for the index fund.)
Still own some high expense or loaded funds? Run them through the calculator to see just how much they’re costing you. This calculation minimized the effect of the load, because it assumed you held that investment for 30 years. More likely, you churned that fund every few years, paying a new load every time. That’s a recipe for retirement disaster. This is one of those instances when just a little knowledge can save you some serious coin. Kudos to Texas for aiding in the fight against Wall Street shenanigans.
A reader wrote in to point out that http://www.401kfee.com has another cost of fees calculator. He says, “This one provides readers with a cost of fees calculators and allows you to use current nestegg invested at X% ROR and Y% fees compared to Z% fees in a lower cost mutual fund. And in comparison to the Texas State calculator, this one allows you to add to you original nestegg, A dollars yearly. “