Fund Expenses Are A Drag

9/18/2017


A fund's expense ratio is the percentage deducted each year to cover management and administrative costs. Expenses are the most predictable drag on performance — every dollar paid is a dollar less earned.

Thankfully, you control what you pay to invest in funds. Smart investors know that a difference in expense ratios that looks small on paper can have a big effect over time. Consider the table below, which shows the cost of funds charging various expense ratios. We assumed a $25,000 investment, a 10% annual return, and a 10-year holding period.

FUNDS CAN BE COSTLY
The table shows the impact of various fund expense ratios on a $25,000 investment growing at 10% per year for 10 years. For example, a 1.00% annual expense ratio generates fees of $4,158 and has an opportunity cost (foregone earnings lost because of fees) of $2,042, for a total of $6,200. Factoring in both costs, the effective annualized return drops to 8.9%.
-------- After 10 Years --------
Fund
Expense Ratio
(%)
Expenses
($)
Opportunity
Cost
($)
Expenses And
Opportunity
Cost
($)
Ending
Value
($)
Annualized
Return
(%)
0.10
436
210
646
64,198
9.9
0.20
867
418
1,285
63,558
9.8
0.30
1,294
625
1,919
62,924
9.7
0.40
1,717
831
2,548
62,296
9.6
0.50
2,134
1,036
3,170
61,673
9.5
0.60
2,548
1,239
3,787
61,056
9.3
0.70
2,957
1,442
4,399
60,445
9.2
0.80
3,362
1,643
5,005
59,839
9.1
0.90
3,762
1,843
5,605
59,238
9.0
1.00
4,158
2,042
6,200
58,643
8.9
1.10
4,550
2,240
6,790
58,054
8.8
1.20
4,938
2,436
7,374
57,469
8.7
1.30
5,321
2,632
7,953
56,890
8.6
1.40
5,701
2,826
8,527
56,317
8.5

Say you invest in a fund that charges 0.90%, the median expense ratio for U.S. large-cap blend funds. After 10 years, the total cost of holding the fund is $5,605. That includes the sum of expenses paid, roughly $3,762, plus $1,843 in investment earnings foregone because of the expenses. After 10 years, the investment is worth $59,238, which equates to a 9% annualized return.

Compare that to a fund charging only 0.20%. A $25,000 investment growing at 10% would have a total cost of only $1,285, including $867 in management expenses. The investment grows to $63,558, or $4,320 more than the higher-cost fund.

ETFs the frugal choice

Fund expenses are among the most effective predictors of future performance. Still, rather than fixate only on fees, investors should focus on low-cost funds and exchange-traded funds (ETFs) with solid track records. These days, fund investors increasingly favor ETFs because of rock-bottom expenses and ease of trading.

The 40 ETFs listed below are among the cheapest in their category — they have an average expense ratio of only 0.08%. Moreover, the funds have delivered solid relative returns over the past 12 months and three years. Note that commissions apply to most ETF trades, though some brokers waive trading fees for select ETFs. 

Shopping for a bargain? Consider Schwab U.S. Broad Market ($60; SCHB), which has a tiny 0.03% expense ratio. Holding 2,015 stocks, the ETF tracks the Dow Jones U.S. broad stock market index. The Schwab fund has a five-year annualized return of 13.9%.

40 BARGAIN BIN FUNDS
The 40 exchange-traded funds (ETFs) listed below rank among the cheapest in their category and have solid track records. Like all ETFs, the funds are bought through a broker, typically for a commission.
---- Total Return ----
Fund (Price; Ticker)
Year-
To-Date
(%)
3-Year
Annual.
(%)
Expense
Ratio
(%)
Category
Vanguard Inter.-Term Corp.
($88; VCIT)
5.1
4.4
0.07
Corporate bond
Schwab Emerging Markets
($27; SCHE)
27.2
3.3
0.13
Emerging markets
Vanguard FTSE Europe ($58; VGK)
23.7
3.8
0.10
Europe
Schwab U.S. TIPS ($56; SCHP)
2.6
1.7
0.05
Infl.-protected bond
Schwab U.S. Aggreg. Bond
($53; SCHZ)
3.6
2.9
0.04
Inter.-term bond
Vanguard Mort.-Backed
($53; VMBS)
2.6
2.5
0.07
Inter.-term gov't
Schwab Int'l Equity ($33; SCHF)
20.2
3.9
0.06
Int'l large-cap
iShares Core S&P 500 ($252; IVV)
12.9
10.2
0.04
Large-cap blend
Schwab U.S. Broad Market
($60; SCHB)
12.4
9.7
0.03
Large-cap blend
Schwab U.S. Large-Cp. Gro.
($66; SCHG)
19.0
11.1
0.04
Large-cap growth
SPDR S&P 500 Growth
($124; SPYG)
18.6
11.7
0.15
Large-cap growth
Schwab U.S. Large-Cp. Value
($51; SCHV)
7.8
8.7
0.04
Large-cap value
SPDR S&P 500 Value ($115; SPYV)
6.3
7.8
0.15
Large-cap value
iShares Core S&P Mid-Cap
($175; IJH)
6.5
8.8
0.07
Midcap blend
Schwab U.S. Mid-Cap
($49; SCHM)
10.0
8.8
0.05
Midcap blend
SPDR S&P 400 MidCp. Gro.
($144; MDYG)
9.2
9.4
0.15
Midcap growth
Vanguard Mid-Cap Growth
($121; VOT)
15.2
8.2
0.07
Midcap growth
SPDR S&P 400 MidCp. Value
($96; MDYV)
3.4
7.7
0.15
Midcap value
Vanguard Mid-Cap Value
($104; VOE)
8.6
8.7
0.07
Midcap value
Fidelity MSCI Cons. Discret.
($36; FDIS)
11.5
10.4
0.08
Sector — cons. cyclical
Fidelity MSCI Cons. Staples
($33; FSTA)
7.8
9.5
0.08
Sector — cons. staples
Fidelity MSCI Energy ($18; FENY)
(13.8)
(10.7)
0.08
Sector — energy
Fidelity MSCI Financials
($36; FNCL)
6.2
12.0
0.08
Sector — financial
Fidelity MSCI Health Care
($40; FHLC)
22.8
11.2
0.08
Sector — health
Fidelity MSCI Industrials
($35; FIDU)
10.8
10.2
0.08
Sector — industrials
Fidelity MSCI Materials
($32; FMAT)
13.7
6.6
0.08
Sector — materials
Schwab U.S. REIT ($42; SCHH)
2.2
8.8
0.07
Sector — real estate
Fidelity MSCI Info. Tech
($46; FTEC)
25.7
16.2
0.08
Sector — technology
Fidelity MSCI Telecom
($32; FCOM)
0.0
8.5
0.08
Sector — telecom
Fidelity MSCI Utilities ($36; FUTY)
14.6
13.0
0.08
Sector — utilities
iShares Core 1-5 Year ($50; ISTB)
2.0
2.0
0.06
Short-term bond
Schwab Shrt.-Term Treasury
($50; SCHO)
0.8
0.8
0.06
Short-term gov't
iShares Core S&P Small-Cap
($70; IJR)
2.7
10.2
0.07
Small-cap blend
Schwab U.S. Small-Cap
($65; SCHA)
6.2
7.9
0.05
Small-cap blend
SPDR S&P 600 Smll. Cp. Gro.
($217; SLYG)
4.8
11.3
0.15
Small-cap growth
Vanguard Small-Cap Growth
($149; VBK)
12.1
7.2
0.07
Small-cap growth
SPDR S&P 600 Smll. Cap Val.
($119; SLYV)
0.7
9.0
0.15
Small-cap value
Vanguard Small-Cap Value
($124; VBR)
3.3
8.2
0.07
Small-cap value
Vanguard Total Int'l Bond
($55; BNDX)
1.6
3.5
0.12
World bond
Vanguard Total World Stock
($70; VT)
17.1
6.9
0.11
World large-cap stock

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