In the first part of this series, I discussed the basics of mutual fund expenses. In this section I would like to explore the reality of how mutual fund expenses will impact your bottom line.
As of May 11, 2009, Schwab announced that it will reduce its expense ratio on several mutual funds. One in particular caught my eye: The Schwab S&P500 fund (SWPIX). This fund lowered its expenses from .36% to .09 %. This is a big jump!
As the Schwab S&P 500 Fund is a passive fund or index fund, the expense ratio has a big impact on your bottom line. Also, the Schwab S&P 500 fund should hold the same assets as any other S&P 500 fund, so now that the expenses are lower it could save you money.
Here’s an example of how fees will impact you bottom line. Since the Schwab fund just lowered its fees we can not use it as a historical example. The Vanguard S&P 500 fund currently has an expense ratio of .16%, while the Dreyfus S&P 500 fund has an expense ratio of .50%. The difference of these two fund’s returns on an annualized basis for 10 years is .39%. This difference is essentially the spread in their expense ratios over the last ten years since the fees do change over time. If the funds more or less hold the same assets, why buy the fund with the higher expense ratio and pay more money for the same product?
Exploring this further will illustrate the impact on your portfolio. A $100,000.00 investment in the Vanguard fund for the last 10years would produce a return almost $3400 higher than the Dreyfus fund based on historical data. While every S&P 500 fund will produce slightly different results (regardless of expenses), it’s important to be cognizant of the impact expenses can have on your portfolio. $3400 here and there can make the difference in your ability to reach your goals, so make sure you know where your money goes and what it costs you!
Wednesday, May 13, 2009
Understanding Costs! Mutual Fund Expenses Part I
One of the aspects of investing that is often over-shadowed by investment returns is the importance of expense ratios in mutual funds. These expenses can erode returns and are often misunderstood by investors. Expense ratios are the fees paid to the fund itself by investors like you and me. These fees are expressed as a percentage and go to cover the costs of running the fund.
The expense ratio of a mutual fund wraps several fees into one number making it somewhat easy to understand. The number is expressed as a percentage of assets under management. For example, if you own $10,000.00 of a mutual fund with a 1% expense ratio, your yearly costs would be $100.00. That $100.00 is used to pay the fund’s manager(s), administrative costs, and possible 12b-1 fees. 12b-1 fees are used for marketing, advertising, and the costs of selling the fund (commissions paid to brokers). Yes, part of the expenses you pay every year goes to advertise the fund, as well as compensate brokers who sell the fund and receive commissions. Now, not every fund carries a 12b-1 fee, and I strive to stay away from those that do!
There are two general types of mutual funds: Actively managed and passively managed. An actively managed fund is a fund who’s manager strives to outperform a market index. These funds, on average, have expense ratios in the 1.4% range. It’s higher for international funds and lower for fixed income funds. Passively managed funds are funds who’s manager strives to mimic or capture the returns of an index. These funds on average have much lower expense ratios. Why? Well, the guess work is taken away from the fund’s manager. If a fund’s job is to follow the S&P 500 index, the stock picking is already done. The fund doesn’t need to pay a fund manager to go out and find investment opportunities because the fund’s objective is set….replicate the S&P 500 index.
While the above paragraph may be a bit difficult to grasp, the understanding of expense ratios should not be. It’s very simple…..the higher the expense ratio, the more you pay!
Some funds may be worth the extra costs, but you should at least know what you are paying in expenses before you buy! Stay tuned for Part II, as I will explore an example and illustrate the affects of expense ratios on long-term returns.
The expense ratio of a mutual fund wraps several fees into one number making it somewhat easy to understand. The number is expressed as a percentage of assets under management. For example, if you own $10,000.00 of a mutual fund with a 1% expense ratio, your yearly costs would be $100.00. That $100.00 is used to pay the fund’s manager(s), administrative costs, and possible 12b-1 fees. 12b-1 fees are used for marketing, advertising, and the costs of selling the fund (commissions paid to brokers). Yes, part of the expenses you pay every year goes to advertise the fund, as well as compensate brokers who sell the fund and receive commissions. Now, not every fund carries a 12b-1 fee, and I strive to stay away from those that do!
There are two general types of mutual funds: Actively managed and passively managed. An actively managed fund is a fund who’s manager strives to outperform a market index. These funds, on average, have expense ratios in the 1.4% range. It’s higher for international funds and lower for fixed income funds. Passively managed funds are funds who’s manager strives to mimic or capture the returns of an index. These funds on average have much lower expense ratios. Why? Well, the guess work is taken away from the fund’s manager. If a fund’s job is to follow the S&P 500 index, the stock picking is already done. The fund doesn’t need to pay a fund manager to go out and find investment opportunities because the fund’s objective is set….replicate the S&P 500 index.
While the above paragraph may be a bit difficult to grasp, the understanding of expense ratios should not be. It’s very simple…..the higher the expense ratio, the more you pay!
Some funds may be worth the extra costs, but you should at least know what you are paying in expenses before you buy! Stay tuned for Part II, as I will explore an example and illustrate the affects of expense ratios on long-term returns.
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