Are High Mutual Fund Fees Really So Bad?

Image via WikipediaI was over at Morningstar.Com reading about expense ratios and star ratings. It turns out that lower expense funds do better than higher expense funds. Also expenses are a better predictor of future returns than Morningstar's own star rating. 
 
Russel Kinnel, Director of Mutual Fund Research, says the star rating is useful but that the expense ratios predict better everytime. "Expense ratios are a strong predictor of performance. In every asset class over every time period, the cheapest quintile produced higher total returns than the most expensive quintile. 
 
The math says for every 1% of additional fees, 28% of the total return will be missing. Assume that you are just starting investing and you have 35 years to invest. The balance in your account is $25,000. If returns on in investments in your account over the next 35 years average 7 percent and fees and expenses reduce your average returns by 0.5 percent, your account balance will grow to $227,000 at retirement, even if there are no further contributions to your account. If fees and expenses are 1.5 percent, your account will grow to only $163,000. The difference of 1 percent in expenses gets you 28 percent less. 
 
This example demonstrates why expense ratios are critical in your investing. A 1 percent difference over time will substantially reduce your investments. We are told, many investment gurus, if you can get consistently high returns the extra expense is not important. But who gets consistent high returns? I have some trouble with Morningstars star rankings. The ranking are a look backwards of fund performance. But we all know how funds can be up one year and down the next. On the check list of rating a fund, it's way down the list. After seeing the math on expense ratios, their is finally a good indicator that is more concrete in nature. When investing your precious dollars every advantage must be taken. It's your responsibility to be aware of all ways to maximize your return. 

The ETF Price War

Image via WikipediaThe cost to invest in ETF's has dropped dramatically this year. From the high commission fees of previously years, to sometimes zero commission fees, today. The competition between brokerage houses has benefited the consumer. With the amount of money these companies make it's about time they give a break to the consumer. It really helps the beginning investor the most. Because they're the ones who need the most help in the beginning years of investing. 
 
My favorite investment company Vanguard has expanded it's ETF line-up with 20 new funds. The most known fund the Vanguard 500 Index Fund now has an ETF version. With an expense charge of only 0.06%. The lowest cost for any S&P 500 ETF. The new funds bring Vanguards ETF offerings to 66. 
 
This is a great thing for competition in the investing world. Charles Schwab cut expense ratios and removed trading commissions on all it's own ETFs. Fidelity has also waived fees on 25 iShares ETFs. In assets, State Street and iShares are first and second in assets. But Vanguard is third with $103 billion in assets, with a $14 billion increase in assets so far this year. 
 
All this competition is a great benefit to the consumer. Vanguards new ETFs include an international real estate fund, mini bond funds, and value and growth-style stock funds. 
 
This is something along time coming. It benefits new investors and old alike. The low expenses and ease of investing will only attract new investors and impact the brokerage houses bottom line for the better. As always for long-term investors, regular index mutual funds with low cost, remain an excellent option. 

Investing 101: Index Funds

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If your thinking about getting into investing and want an easy way to get your feet wet why not try Index Funds. We all have the common problem of which of the 3000 plus mutual funds do we put are money in. You can search for the hot fund or the fund with the great long term track record. But when you purchased it, it tanked. What to do? I would just like to pick a fund that will let me get some sleep at night!

The answer for you is Index Funds. Jack Bogle founder of Vanguard Funds and pioneer of index funds says," Why look for a needle in a haystack when you can buy the whole haystack." Get great diversification by buying everything. You will ride the markets ups and downs like a roller coaster. But always with a upward trend. You will be at ease in your choice of index funds because you won't have second thoughts. How can you? You own everything, you don't have to believe you have the wrong stock or fund, you own them all. Another plus for your index portfolio is, by not buying and selling a lot you'll save all those transaction fees. Also buying from Vanguard, there will be none if you buy their mutual funds directly.

Now what do you do to get started? What funds to buy? Start with the basic three with percentage allocations:

• Total Stock Market Index Fund. 60%
• Total International Market Index Fund. 30%
• Total Bond Market Index Fund. 10%

This is a good place to start. Your allocations can be adjusted based on years till retirement. There are many other index funds to add to this list for further diversification. There are TIPS, Small-Cap,Specialty Foreign, REITs and others. As your portfolio increases new money can be put here. To get some good advice study the work of John Bogle. He's the main source to go to. Others like Paul Merriman on his web site Fundadvice.com. He offers his own proprietary work on index funds including his "Ultimate Buy an Hold Strategy". He offers sample index fund portfolios. He also produces many educational videos on investing. His active web site keeps you going back for more good advice. Also Paul Farrel over at Marketwatch.com keeps a scoreboard of the top eight index fund portfolios. He has there performance over the last 10 years and its updated daily. You'll also enjoy his "Andy Rooney" style commentary's. He is many years experience in the equity markets and writes a thoughtful column. Here's a list of the Index Fund Portfolios Courtesy of Paul Farrel's column at Marketwatch.com.

Take the strain and worry of investing away with index funds. Open an account Or if you have one see if you can purchase them there. If you go to Vanguard Funds there is a minimum investment of $3000. At Schwab their index funds have a minimum of $100. You can start there and latter move to the mother ship Vanguard. To be sure you will be saving money because a nice feature of these index funds is the low expense fees. Vanguards Total Stock Market Index Fund has an expense ratio of  0.18%. One of the lowest. But be careful because I have seen some expense fees as high as 1.5%. There is no reason for these high fees.