When it comes to investing, every dollar counts. Yet too many investors are throwing money away unnecessarily.
A recent study by the Investment Company Institute showed that the average investor paid 1.07% in expenses on stock mutual funds during 2006. Although that number has fallen dramatically over the past 25 years -- stock funds charged an average of 2.32% in 1980 -- there's still plenty of room for improvement.
Don't get loaded down
Surprisingly, sales loads still represent a decent chunk of fund expenses. The average charge paid by load-fund buyers was 1.31% in 2006. While small investors typically pay much higher loads -- 3%-5% is an average range -- discounts are often available for larger purchases, as well as investments through employer plans.
There's little reason to pay any load at all. Research has shown that load funds generally offer no corresponding improvement in performance. In fact, the higher expenses tend to bring down net returns. If you invest $5,000 each year for 30 years, avoiding a 4.75% load would save you more than $7,000 in sales charges alone. Factor in the effect of extra earnings (assuming a 10% return), and that number grows to almost $43,000.
Be a bargain shopper
As imposing as those big sales loads are, they pale in comparison to the slow torture of ongoing fund expenses. Year in, year out, they work like compound interest in reverse, reducing your annual returns by a relatively small amount that adds up to big money over time.
One lousy fund that fellow Fool Selena Maranjian recently examined charges more than 2% per year in expenses. Although plenty of low-cost funds exist, you'll also find quite a few that make you pay through the nose. And with funds, you don't get what you pay for -- often, low-cost funds give you better returns.
Just by picking lower-cost funds, you'll save yourself a bundle. Index funds are the bargain basement of mutual funds; the cheapest make you pay as little as 0.2% each year in fees. Even if you want active management, however, you can find plenty of good choices that charge 1% or less in fees.
The same stocks ... for less
You may be surprised at how similar the portfolios of low-cost and high-cost funds can be. For instance, the ProFunds Consumer Services Fund (FUND:CYPSX), with an expense ratio of 2.58%, counts Wal-Mart (NYSE:WMT), Home Depot (NYSE:HD), Disney (NYSE:DIS), and CVS Caremark (NYSE:CVS) among its top holdings. Yet you'll also find those stocks in the top 25 holdings of the Vanguard Growth Index Fund (FUND:VIGRX) -- with an expense ratio of just 0.22%.
Your lifetime savings with lower expenses may surprise you even more. Again, if you invest $5,000 each year for 30 years, paying a 2% fee from a gross return of 10% (leaving a net return of 8%) will leave you with about $612,000. But if you cut that fee to 1%, thereby netting a 9% annual return, you'll end up with about $743,000 -- a difference of $131,000.
To succeed with long-term investing, you cutting costs is essential. By choosing funds that don't charge you an arm and a leg, you'll keep far more of your own money.
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