Size Matters: Fees Addition

This post is all about the fee’s knees. Yikes. I really wouldn’t be surprised at all if you stopped reading after the terrible pun. But really, fees are just one of many things you need to look out for when investing. I’m going to be using a bunch of fancy charts to illustrate how fee’s work and how they can be detrimental if too high.

To start, fees, also known as expense ratios, are completely different for actively managed funds and passively managed funds. According to Morningstar, the average expense ratio for an actively managed fund is around .75% compared to .17% for a passively managed fund.

The main reason people would pay more in fees is when they want a team of people who have access to more information in lesser known areas (i.e. foreign companies or small-cap companies). This would be considered an actively managed fund. A fund that actively trades within the fund based on relevant data or parameters set by the team. Sometimes they out-perform the benchmark and sometimes they under-perform the benchmark. Regardless, because they are actively changing the weightings in the fund, they charge a higher expense.

Now, let’s see how fees affect your portfolio growth. Let’s assume you invest $100,000 and the market, before fees, grows at 5% for 30 years. How much does the expense ratio of the mutual funds affect you? Great question. Here’s a fancy chart:

 

Actively Managed Passively Managed
Starting Amount  $100,000  $100,000
Growth Rate 5% 5%
Expense Ratio 0.75% 0.17%
Net Growth Rate 4.25% 4.83%
Years Invested 30 30
Value at 60  $348,563.50  $411,687.40

 

About $63,000! All due to fees. This is without adding any money in throughout those 30 years. To be fair, this is just taking the average and there are a lot of factors that would change this. But, for the sake of the argument today, we are just using the average expense ratio to make a point. You could also make the point that an actively managed fund might out perform a passively managed one. Which could be a valid point. But again, for the sake of the argument today, we are just assuming that everything is equal except the expense ratio. Gotta love perfect worlds like this one.

Now, in this next scenario, we are going to add $500 a month to our portfolio. This would be an additional $180,000 throughout the 30 years, again, assuming all things equal besides the net growth rate. Fancy chart:

 

Actively Managed Passively Managed
Starting Amount  $100,000.00  $100,000.00
Growth Rate 5% 5%
Fees 0.75% 0.17%
Net Growth Rate 4.25% 4.83%
Monthly Addition  $500.00  $500.00
Years Invested 30 30
Value at 60 $719,980.17 $827,938.66

 

You now have approximately $107,000 more with a portfolio with .58% less in annual fees.

Lastly, in this previous scenario, how many years would you need to continue investing with an actively managed portfolio to break-even with the passively managed one? Another great question. Approximately 3 more years. 3 years strictly because of fees. That might not sound like a lot now, but when you want to retire and have to work 3 more years, you might be kicking yourself.

Now, all that being said, there are so many factors that play into this. Active management might be better in down markets than passive. Not sure, but it’s a possibility. Also, there’s a high probability that the growth rate between the two portfolios won’t be the exact same. I understand that. I just wanted to show you that you need to be aware of what you’re buying. Regardless of if it’s an actively managed fund, make sure the return you are getting justifies the expense being charged.

You’re probably already aware of expense ratios and how they are important because if you’re reading this blog then you’ve heard of Vanguard. And Vanguard is blasting people’s ears about fees. Which, apart from being a really good marketing strategy, is very important for people to understand. To be clear, I’m not promoting a straight index (passive) strategy or advocating for actively managed funds, I’m just pushing for you to be aware of what you’re being charged.

So, cheers to lower fees and more money! Also, here’s my shameful plug: please follow and share if you like what you read. I’d love you a little more if you did.

 

 

Advertisements

One thought on “Size Matters: Fees Addition

Add yours

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Create a website or blog at WordPress.com

Up ↑

%d bloggers like this: