According to the Securities and Exchange Commission publication Mutual Fund Investing – Look at More Than a Fund’s Past Performance, tip number one is to scrutinize the fund’s fees and expenses. Specifically,
A fund with high costs must perform better than a low-cost fund to generate the same returns for you.
Got it. However, the SEC goes on to say something even more meaningful:
Even small differences in fees can translate into large differences in returns over time. For example, if you invested $10,000 in a fund that produced a 10% annual return before expenses and had annual operating expenses of 1.5%, then after 20 years you would have roughly $49,725. But if the fund had expenses of only 0.5%, then you would end up with $60,858.
Coincidentally, the expense ratio of the typical ETF is in the 0.4% to 0.5% range – compare that to the expenses of your mutual funds. Here’s a quick and easy way.
The SEC recommends using FINRA‘s calculator to find out how much mutual funds are eating into the future value of your portfolio. We plugged in a couple of random large cap mutual funds and compared the expenses and future value against iShares S&P Global 100 Index Fund (NYSEArca: IOO).
Using conservative figures like a starting portfolio of $100,000 and an expected annual return of 7%, the difference in the ending values are breath taking.
Despite the assumption of identical investment returns, the ETF outperforms the first mutual fund by almost $50,000 and the second fund by $65,000 over a 20 year period. To avoid embarrassment, we disguised the names and tickers of the mutual funds which are both from well known fund-families.
Learn more about the Financial Industry Regulatory Authority (FINRA) here.