I want to briefly highlight the fees you’re paying for your investments. Many people don’t realize that mutual funds and ETFs charge annual fees, even within your 401k. For those who are aware of the fees, they likely don’t appreciate the full impact on their portfolio.
Mutual funds and ETFs charge annual fees, called expense ratios. The fees are highest for actively managed funds, as much as 2.5%, and lowest for passive index ETFs (~0.05%). The average, of course, falls in the middle at about 1.3%.
The justification for higher fees in active funds is that they employ high-priced genius fund managers to provide out-sized returns. Unfortunately this has not proven true; passively managed ETFs have outperformed their higher-fee counterparts. The only thing genius about money managers is their ability to get rich selling you a bad product.
If you work with a financial adviser, they’re often paid out of these expense ratios. The payout for the adviser is commonly as much as 50% of the annual fees. They have every incentive to put you in the funds that will earn them the highest commissions, regardless of what will earn you the best returns (low-cost funds).
Personal Capital helps me track and identify the expense ratio of all my investments, and I’ve made a point to invest in low cost passive ETFs. .
I’m doing pretty well on fees, paying a total of 0.20% compared to their benchmark of 0.50%.
The graph is measuring how much of my investment earnings are lost to fees. While 0.20% seems like a small price to pay, it adds up to $12,784 over the next 8 years. If I were paying 2% for actively managed funds it’d cost more than $100,000!
The affects of fees on investment returns has been well-covered and consumer education has led to a massive movement into low-cost passive funds. Instead of regurgitating a bunch of information, I’ll point you to a few articles I really like:
- 20SomethingFinance writes a nice guide to Passive Investing. It’s part of a larger series on investing outside of your 401k and gives useful, and practical, advice for getting started.
- Nerdwallet gets mathy and distills a millennial’s potential loss to fees as $590,000! Obviously it’s different for each person, but I like articles that put a real dollar amount out there.
- And for something different… Marketwatch discusses how the huge growth in index ETFs popularity, there’s a reasonable fear that the shear size of the funds are a threat to efficient markets. Of course, that assumes markets are efficient in the first place…
And finally, if you’re interested in getting a summary of your own investment fees you should check out Personal Capital. It’s completely free to sign up for, and you’ll get access to useful summaries like the image above.
Cool, that’s all I got. As always, buy small used cars, live in a small house, and invest in things with small fees 😉