There's only so much you can do to pick investments that will give you the best returns. Doing what you can to minimize your costs, however, will always put money back in your pocket.
Unfortunately, investing involves a tug of war between you and your investments. Even if you invest directly in individual stocks, you have to stay vigilant to make sure that company managers aren't taking too much compensation out of company profits, and you also have to keep an eye on your broker to make sure your commissions don't get out of control.
Moreover, if you invest in mutual funds or ETFs, you have a whole other layer of expenses to deal with -- one that can make a huge difference to your net worth over a lifetime of investing.
Don't get fleeced
Too often, mutual fund investors fall prey to the fees and expenses that funds charge. Lulled by the promise of better performance, you may discount the huge impact that high expenses have on your prospects for future gains.
For instance, take a look at these funds:
|
Fund |
Annual Expenses |
5-Year Return |
Holdings Include: |
|---|---|---|---|
|
Pacific Advisors Multi-Cap Value A (PAMVX) |
3.20% |
(0.02%) |
Chevron |
|
Munder Technology A (MTFAX) |
3.46% |
1.01% |
Apple |
|
Dunham Large-Cap Growth C (DCLGX) |
2.77% |
(9.64%)* |
Microsoft |
Source: Morningstar. *Three-year return; fund not yet open for five years.
It's tough to blame the stocks that these funds own for their poor performance. In a market that has punished good and bad stocks alike in recent years, many funds have seen their gains from the previous bull market go up in smoke. But these three funds have trailed the S&P 500 substantially, and they fell short of their fund category averages by an even bigger margin.
Given how badly the overall market has performed over the past two years -- the recent rally notwithstanding -- few investments have managed to avoid the carnage that these funds have experienced. Yet as returns rose and fell, the one constant was that a huge amount of money was disappearing from investors' fund accounts -- because of expenses.
Picking alternatives
The saddest part is that it's easy to avoid high fund fees. Depending on what area of the market you want to focus on, there's almost always an index-tracking ETF or mutual fund that will get you the exposure you want a lot more cheaply.
For instance, value investors can look to an ETF such as Vanguard Value (VTV), with its 0.15% expense ratio. Growth investors might instead try iShares Russell 1000 Growth (IWF), which charges 0.20% annually. And if you're looking for a technology sector fund, the Technology Select SPDR (XLK) clocks in at just 0.21%. All of those ETFs are outperforming the funds in the chart above.
A percentage point or two may not seem like that big a deal in any given year. But over time, it really adds up, as you can see:
|
By Doing This … |
You Save This Much Per Year on a $100,000 Account … |
Which Adds Up To This Much Over 30 Years |
|---|---|---|
|
Move from Pacific Advisors to Vanguard Value |
$3,050 |
$202,600 |
|
Move from Munder to Technology Select SPDR |
$3,250 |
$215,900 |
|
Move from Dunham to iShares Russell 1000 Growth |
$2,570 |
$170,700 |
Source: Morningstar. Assumes 5% return on accumulated savings.
If you knew you were giving up six-figure cash by sticking with a fund that's too expensive, you'd probably switch out to a lower-cost alternative a whole lot faster.
Be smart
Of course, if you're looking to beat the indexes rather than match them, then you're going to have to go beyond index funds. And in all likelihood, you'll have to pay more in expenses than you would for an index fund.
But if you decide to swing for the fences, it's important to understand that higher expenses put your fund at a distinct handicap. The best managers find ways to overcome that handicap over time. The majority of funds, though, find that obstacle too great to beat -- and it's their shareholders who suffer.
