Mutual Fund Management Fees DESTROY LONG TERM RETURNS
Many investors tend to ignore the ongoing costs of mutual funds as these cost are not directly paid by the investor as they are paid by the fund to the manager before any returns are paid out to investors. Investing in low cost diversified mutual funds or exchange traded funds is a great strategy to mitigate the long term impact of high expenses associated with many mutual funds.
Many people may look at a fund that has a .25 expense ratio and compare it to a similar fund that has a .5% expense ratio and think that the difference between the two amounts is so small and will not matter much in the long run. This type of thinking is incorrect as not only does the more expensive fund cost .25% more per year which is $250 on a $100,000 investment. Now you may not think that is much but multiply that by 30 years and that number becomes $7,500. Then you also need to take into account the lost investment returns over those 30 years as that $7,500 could have been making you money each year for 30 years! See below for a few examples that show the true cost that expense ratios can have on your long term investment returns:
The first scenario that we will look at is the impact of a .25% expense ratio on your returns over 30 years assuming a $100,000 initial investment, no additional contributions, and a 7% annual rate of return. This would be a good example of a low cost mutual fund and as you can see below the impact of the expense ratio is still a fairly large amount at $55,070. Your final expected account value in 30 years is around $700,000 after the fees are taken into account.
Now let's look at how much of an impact an increase in the expense ratio of .25% to .5% would have on your portfolio assuming the same assumptions as the first scenario. Now the impact over 30 years related to the expense ratio is $106,280 and your final expected account value is about $51,000 lower just as a result of that small increase in the expense ratio!
The two examples above are typically associated with mutual funds with low expense ratios. Let's examine the impact of a typical mutual fund with an expense ratio of 1% and how much greater the impact is compared to the examples above. A typical mutual fund will cost you $198,146 due to the expense ratio and your final expected account value drops to approximately $563,000 which is about $143,000 less than as similar fund if it had charged a .25% expense ratio rather than a 1% expense ratio.
As you can see from the examples above the impact the expense ratio of a mutual fund can have on your portfolio can be significant. When comparing the cost of a mutual fund with a 1% expense ratio to a fund with a .25% expense ratio over 30 years using a $100,000 initial investment the higher cost fund will significantly hurt the ending value of your portfolio with an estimated loss in earnings of $143,000! You could buy a new house with $143,000!
The main point is to make sure that when comparing mutual funds and other investments you take a serious look at the expense ratios of the funds as they can significantly impair your future returns and portfolio value. There are many mutual funds offered to investors with similar strategies and holdings but with varying expense ratios. When comparing funds that are the same or similar you will likely have much better results in the long run if you choose the fund with a low expense ratio as you can see from the examples above.
You work hard for your money so don't choose the wrong investment and lose out on significant wealth generation by ignoring the expenses associated with that investment and the long term impact on your portfolio.
This article is for informational purposes only and should not be considered legal, investment, financial or tax advice. Please consult your own adviser before making any financial decisions.