Fees Matter - reading this article could be worth six figures to you!

Recently I met with a couple of clients who had rolled pension money from an old employer to a bank IRA.
In both cases the bank placed the client in mutual funds with 5% loads and  and annual fees that averaged 1.30%. Also, in the cases I am referring to, the mutual funds have historically under performed their benchmarks.


People will often give their hard earned retirement to a bank or Wall St firm in the belief that they are doing the prudent thing with their money.

How fees can effect your investment returns:  Lets take a 40 year old investor with $100,000 to invest and who plans to save another $5,000/year for the next 25 years. Below are 3 scenarios seen in the industry:

1. A local advisory firm charges a 1% advisory fee to "actively" manage the money. If the adviser chooses mutual funds there can be a 5% initial charge (load) plus fees of 1.30% within the mutual funds

2. A bank investment department that has no advisory fee but collects a load of 5% for recommended mutual funds. In addition, there are the 1.30% ongoing mutual fund fees

3. An adviser who believes in passive investing (buying and holding a portfolio of index funds). The adviser charges .25%/year and the index fund fees average .20%. This adviser’s fees are lower because they don't have to research mutual funds and move Joe from fund to fund when a fund underperforms or changes managers.

Next,

We know, from many study’s, that there is not a system to choose mutual funds or stocks that consistently outperforms the market. In fact, over time, the vast majority of mutual funds and stock pickers have long term returns that equal the averages (or the index return). Therefore, in the table below, we can only assume all 3 scenarios earn the same return.

The differences in the long term dollar values can be staggering. A review of the table below shows that by passively investing an investor can be almost $300,000 ahead of the other options.

  

	Fee based advisor charging 1% + mutual fund fees of 1.00%	"Free" advisor - typically banks and advisors at brokerage houses	Fee only advisor who charges .25% and invests in low cost index funds with .25% fee
Initial amount	$100,000	$100,000	$100,000
annual addition	$5,000	$5,000	$5,000
up front load	5.00%	5.00%	0.00%
annual fees	2.30%	1.30%	0.45%
yrs to maturity	25	25	25
Est portfolio return	8.00%	8.00%	8.00%
$ amount earned	$682,829.04	$834,201.30	$959,325.55

We all want the secret to investing. The secret is keeping fees low. A recent study by Morningstar found that the best predictor of mutual fund performance was fund fees.  

“[When deciding on a fund], the first thing to look at is the expense ratio; the second thing is the turnover rate; the third thing is some measure of past performance… But if you had to look at one thing only, I’d pick expense ratio.”

William Sharpe, 1990 Nobel Laureate in Economics

Here is  a quote from Morningstar:

“All things being equal, funds with high costs are much more likely to produce poor performance because of their cost disadvantage.”

Russel Kinnel, Morningstar, Inc.

If you are interested in learning more about passively investing your money, feel free to email me at mcangelucci@gmail.com