A reader wrote in recently and recommended the website of the Texas State Securities Board to me. Unlike most stuff out there, it is relatively unbiased. He recommended a compound interest calculator (which is nothing special if you know how to use excel or a financial calculator.) But also a calculator which demonstrates the impact of mutual fund expenses, including loads, on your investment returns.
You’ve read on this site before that you should pretty much never buy a mutual fund with a load. Not only do the loads reduce your investment return, they also usually come with higher expense ratios, which further reduce your return. This wouldn’t be so bad if the funds were better than no-load funds, but they almost never are. So you’re paying more for a crappier product. Curious how much more? Let’s take a look at the calculator.
Let’s say you have $100K to invest. You’ll leave the money there for 30 years before withdrawing it. Your choices are an actively managed mutual fund that returns, let’s be generous here and say 7.5% before expenses over that time period and an index fund which returns 8% before expenses over that same time period. Let’s also be generous to that actively managed fund and pretend it actually continues to exist for the full 30 years. The index fund has an expense ratio (ER) of 0.07% and the actively managed fund has an ER of 1.5%. It also comes with a front-load of 6%. What’s the difference after 30 years?
- Loaded, high expense, actively managed fund: $522,960
- Index fund: $985,347
- Difference: $462,387
Now I don’t know about you, but that seems like a lot of money to me. The calculator says that for the actively managed fund you lost $6K to the commission, $117K to the operating expenses ($8K for the index fund), and $235K in opportunity costs ($12K for the index fund.)
Still own some high expense or loaded funds? Run them through the calculator to see just how much they’re costing you. This calculation minimized the effect of the load, because it assumed you held that investment for 30 years. More likely, you churned that fund every few years, paying a new load every time. That’s a recipe for retirement disaster. This is one of those instances when just a little knowledge can save you some serious coin. Kudos to Texas for aiding in the fight against Wall Street shenanigans.
Addendum:
A reader wrote in to point out that http://www.401kfee.com has another cost of fees calculator. He says, “This one provides readers with a cost of fees calculators and allows you to use current nestegg invested at X% ROR and Y% fees compared to Z% fees in a lower cost mutual fund. And in comparison to the Texas State calculator, this one allows you to add to you original nestegg, A dollars yearly. “
while i can appreciate the post and that shopping for good low cost alternatives is the best choice, you sure picked the highest extreme possible.
a massive number of years, an expense ratio at the absolute lowest of the low for the index fund (only a few ETFs in the world have that low of a ratio) and 1.5% is on the highest end… and 6% is a really high load.
and 8% was a fairly high performance threshold.
wouldn’t 20 years, 5% load, 1% expense ratio and comparing that to a 0.25%-0.5% be a lot more fair of a fight?
most of the ETFs i have especially the international ones are closer to 0.3-0.4% than 0.07
there are only 5 ETFs in the world at 0.07 or lower
Pretty much vanguard admiral, signal, or even better institutional funds for total stock
Market are at 0.07 or better. Fidelity has classes as well ( for either 401k/403b) as does the govenrment tsp that meet or beat 0.07. For international it is usually a bit higher. Only 1.5% ongoing for an active fund is only around average, and not much higher. Im 35, so 30 years seems perfect.
Oh Z,
You have no idea what the highest extreme possible is. Have you seen this:
http://www.fool.com/investing/mutual-funds/2010/01/27/the-worst-fund-ever-finally-dies.aspx
At any rate, the fun thing about calculators like this is you can plug in any assumptions you want, and see the results yourself. If you think my example is too extreme, use your own.
The expense ratios of the investments I use in my retirement portfolio are:
0.07, 0.09, 0.20, 0.22, 0.12, 0.12, 0.21, 0.22, 0.55, 0.76, 0.03, 0.03, and 0.03 so no, I don’t think my example was unreasonable. I use several rather exotic asset classes and still have an average portfolio ER of less than 0.16.
And 6% wasn’t a high load at all 20 or 30 years ago. It was quite standard and 8%+ wasn’t uncommon at all.
One of my clients is in the process of rolling over a retirement account from a major wall street firm…the one which was the lead underwriter for a major IPO this year.
75% of her portfolio was in Mutual Funds with 5.75% upfront loads, and a 1%-1.5% annual expense ratio.
The remaining 25% was in a global gorilla unit trust. This is not a liquid product and doesn’t have a ticker. I had to go to the SEC website to find out what it was. It was basically a holding of 27 global stocks that charged a 4% upfront load and is liquidated every 2 years, so the loads could be reassessed every other year.
I’m pretty sure this is the rule, not the exception.
I don’t think it’s uncommon for “financial advisors” to charge clients 8% in the first year and 2% every year there after.
It’s pretty amazing just how brazen the thieves on Wall Street can be. I’m just not surprised by stories like these any more.