For everyone that owns mutual funds or exchange traded funds (ETFs), there are costs associated with owning them, and they are not equal. Even if people are aware of the fees they are paying, they are likely unaware of the long term damage the fees, if too high, are costing them over long term investing.
Knowing and minimizing the fees on all mutual funds and ETFs should be a priority for anyone who saves and anyone who helps organize or run a company retirement plan. Also, anyone employed in the financial services field that is a fiduciary should be well aware and advise all of their clients about how fund fees will slowly reduce their investing results over time.
Fees Fees Fees
Fees are a part of investing, whether paid to the government, a company, or a person. However, anyone who investments should know how much they are paying for their investments, whether it is a mutual fund manager, an ETF manager, an individual money manager, financial advisor, or financial planner.
All mutual funds and ETFs have expenses. This makes sense because someone is doing work managing those investment funds. The main way they charge for those funds is through expense ratios. Expense ratios are the fees, as a percentage of the invested money, a mutual fund or ETF charges for managing the investments in the fund. However, fees can vary greatly across very similar funds offered from different companies, or even for the same exact fund from the same company. These fees will chew into returns over time, and could easily reach into the tens of thousands of dollars ($10,000+) or more depending on how much someone has invested. In the following examples, the numbers show it doesn’t take a huge nest egg to cost suppress investment accounts more than $10,000 over the long term. Also, just because the fees aren’t visibly deducted doesn’t mean they aren’t being deducted. Fees are disclosed in a fund’s prospectus, and the prospectus even shows investors how much they’ll pay in fees over time, as shown below. A prospectus explains how a mutual fund or ETF will operate and what it is designed to do. However, a prospectus will not show the effect their fees will have compared to similar funds from competing companies. Below are screenshots taken from the prospectuses of two different 2050 Target Date Funds. A target date fund is designed to have withdrawals begin near the target date. Managers of a target date fund will shift the stock and bond allocation as the target date approaches in an effort to reduce risk and preserve capital.
Example 1: 2050 Target Date Funds
As shown above, the target date funds prospectuses are literally telling investors the amount of fees they should expect to pay over time. All mutual funds and ETFs provide the same guidance. These two funds, the 2050 Target Date Fund from Transamerica (TRNTX) and the 2050 Target Date Fund from Vanguard (VFIFX), are designed to invest similarly over time. Each prospectus also only shows 10 years of fees, which is fairly meaningless if investments are held until the target date of 2050. So assuming someone starts with $10,000 and invest $1,200 every year ($100 per month) for 30 years into each of these funds, the end results are vastly different. Table 1 shows the results of the example investment in TRNTX and VFIFX. Which one would you choose?
With equal growth rates and contributions, the person investing in Transamericas TRNTX has $28,042 less than someone investing in Vanguard’s VFIFX2050 target date. As you can see, even though disclosed fees show someone will pay more, that’s only half the story. The effect of paying higher fees is having less capital after those fees are paid every year. These extra fees and lower account balance each year cause significantly reduced compounding over time. Below are comparisons for S&P 500 index mutual funds, sector ETFs, and a set of niche ETFs. The comparison for sector ETFs and niche ETFs can be found through links below.
Example 2: S&P 500 Index Mutual Funds
Index funds, whether they are ETFs or mutual funds, are becoming more and more popular for investors. Today, I’ll compare two S&P 500 index mutual funds. A S&P 500 index fund’s goal is to mirror the S&P 500 index’s movement. For this example, example investors will invest in the USAA 500 Index Fund Member Shares, USSPX and the Fidelity 500 Index Fund, FXAIX. For this example, the investor started with $0, and invested $1,200 every year for 40 years at a 7% growth rate.
Over $7,000 more in fees and $16,000 less for retirement when investing in the higher fee fund, USSPX. The following table shows the costs for an investor making the maximum IRA contribution, $6,000 per year. Under the same assumptions, a 7% growth rate and a 40 year investment period, the USSPX investor will pay over $33,000 more in fees and end up with a nest egg over $82,000 smaller.
Example 3: Sector ETFs
Click here for Sector ETFs. The example is about information technology sector ETFs.
Example 4: Niche ETFs
Click here to for Niche ETFs. I cover an example about Robotics ETFs.
TSP – Thrift Savings Plan
Fortunately for federal government employees, the Thrift Savings Program (TSP), the federal government equivalent of a 401(k), fund fees are low across the board at 0.042%-0.043% for all funds.
Wrapping Up
This may have been shocking post for many people to read, but I hope it opened your eyes to the world of investment fees. Investment fees should be minimized due to the impact on your investments over time. To recap, the two sides of investment fees are:
1. The fees paid to the fund manager or financial professional that manages your investments.
2. A reduced amount of capital remaining for compounding growth of your investments over time.
If your employer has high cost funds as part of your company retirement fund, you should be able to talk with co-workers and human resources about getting the retirement fund organized into lower cost funds.
I started this blog to help people, and this is one topic that can really help people. Please share this article with others so they can protect themselves from excessive fees and grow their investments for their future as well.
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DISCLAIMER
Disclaimer: Any of the stocks, bonds, mutual funds, or exchange traded funds (ETFs) mentioned in this post or any other post are not a recommendation for purchase. Always do your own research to make an investment decision or consult a finance professional if you so desire. When considering selling any investments, you should consult a tax professional to discuss tax implications.