There seems to be a never-ending stream of evidence that high mutual fund fees depress fund performance and hurt investors’ return.
The most recent article in the popular press explains why high mutual fees can hurt performance.
Two interesting facts stick out.
1. Mutual fund fees make the difference between under- and over-performing a benchmark. With fees included, the average actively managed fund, in which seasoned managers are supposed to pick “winners” in any given market category, under-performed its benchmark over the 10 years ending December 2015 in each of 29 asset categories (and this is all of the categories). Index funds, those funds that track a wide gauge of each of the 29 categories, outperformed the actively managed ones in each category.
In many of the categories the fees – and this means the expense ratio that is already deducted from the fund’s return and is disclosed – were the reason for the actively managed fund’s poorer performance. The upshot of this finding is that if an actively managed fund has low fees, it has a better chance (although still not a great one) of outperforming an index fund. Nonetheless picking talented mangers, sticking with them, and changing course if they leave are very time intensive things to track and manage. The safer bet is to use a low-cost index fund and lessen your work and worries.
2. Average index funds fees are much lower. The average expense ratio for an index fund is about 0.5%, but you can get much lower ones (in the range of 0.05% to 0.1%) at Fidelity, Vanguard, and Schwab, depending upon the market category.
The irony is that expense ratios are lower the broader the fund’s investments. To keep investments uncomplicated and widely diversified, I often recommend a total US stock market fund, a total international stocks market fund, and a total US bond market fund. These three funds cover nearly the stock and bond markets. And their fees are the lowest. Thus, your biggest question is the percentage to allocate to each fund, with more stocks being a more aggressive, long-term strategy.
As you start specializing and get into finer market categories, the expense ratios increase. In other words, you are charged more for specializing. But by specializing, you should also monitor your funds more frequently to make sure you are not over- or under-exposed to any given market category. So not only does specialization require more of your time and attention, it also costs more!
I say stick with less complicated and use low-cost index funds!
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