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Motley Fool Answers' August Mailbag: Is a Fund's Net-of-Fees Return the Most Important Factor?

By Motley Fool Staff – Sep 6, 2018 at 1:01PM

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A fund's real gains after the managers take their cut matter more than raw returns, but there are other "under the hood" issues you can't afford to ignore.

Summer is just about over, but we expect most Motley Fool Answers listeners didn't "sell in May and go away" -- you've been keeping up with matters of finance and investing all along...right?

However, if you happened to take a break from thinking about your money during beach season, you might have missed a few of Alison Southwick and Robert Brokamp's monthly mailbag shows. In which case, you wouldn't have noticed that Ross Anderson -- certified financial planner from Motley Fool Wealth Management, a sister company of The Motley Fool, and a regular on the mailbag podcasts this spring -- took a break from his guest hosting duties as well, so that other Fools could get their time in the sun. Now, he's back to help the podcasting duo address another batch of listener queries.

In this segment, they talk mutual funds, and the fees that sap their returns. As listener Mike notes, if a fund has really outperformed its peers, perhaps a higher fee structure can be justified. Maybe, reply the Fools. But you also need to look at just how it achieved that outperformance.

A full transcript follows the video.

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This video was recorded on Aug. 28, 2018.

Alison Southwick: The next question comes to us from Mike. "There seems to be a lot of rhetoric in today's financial reporting about management fees from mutual funds. I get it. Higher fees mean the consumer pays more and has less in savings. However, I feel that a fund's total return is what counts. As an example, if the total return of an actively managed mutual fund is 12% annualized and a passively managed index fund's total is 10.5%, the higher fees for the actively managed fund are justified. As you know, 12% vs. 10.5% annualized can make a big difference over an investor's lifetime. Am I thinking about this correctly?"

Ross Anderson: I think Mike is thinking about this correctly. Really, the net-of-fee return [the amount that your account goes up] is really what's important. In Motley Fool Wealth Management we run a personal portfolio's program. We manage money for people, so you can paint me with that bias, but that is what we're trying to do, as well, is to deliver on a net-of-fee basis to our clients at a level that's comfortable for their risk. I think he's looking at it the correct way.

The tough thing, when you're looking at a manager, is trying to figure out where that manager's edge is coming from. How are they delivering the outperformance? Is it through taking exorbitant amounts of risk? Is it through discipline? Is it looking at their track record? How long have they been a part of that fund? Whether it's somebody that just opened a brand new product, or they've just changed the manager; those things are really important because a mutual fund, for example, doesn't have to go away if the person that was leading the charge gets fired, or leaves, or makes another choice.

So understanding what's under the hood of that fund [how high is their turnover, are they investing in a way that's consistent with your goals] I think is what's most important, but those net-of-fee returns is what you should be measuring.

Ross Anderson is an employee of Motley Fool Wealth Management, a separate, sister company of The Motley Fool, LLC. The information provided is intended to be educational only, and should not be construed as individualized advice. For individualized advice, please consult a financial professional. The Motley Fool has a disclosure policy.

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