Wasting money aggravates me at the core of my being. If I can get something for free or cheap, I’ll typically pursue it. Of course that can be taken to far, like driving 20 miles out of my way to save a couple cents per gallon on fuel. That’s not a smart use of my time or the money. I will however seek out a free parking spot because I just don’t like spending money on parking. A parking spot is a parking spot in my opinion. My vehicle doesn’t know the difference or get any benefit from one spot over the other, as long as they are both paved, and that’s not even always required. My friends know this quirk about me and I’m fine to spend a couple minutes searching out a free or drastically reduced fee parking spot to save a few bucks.
When it comes to investments, I hate to waste money on excessive fees/expenses. I understand it won’t be free to invest in a mutual fund or buy shares of a stock as there are certain costs that are necessary. However, when you start to investigate further and really look at the expenses, I would virtually guarantee there are some savings you can take advantage of. But why should you worry about high expenses? Because it’s not right to pay for something when you could get it cheaper somewhere else? That’s certainly a mantra I live by, but the main reason it should be important to you is that these fees and expenses are taken right out of your investments. You may be paying for something you didn’t even know about. It’s not illegal or anything shady that your fund company is doing, but if there are two similar funds that invest in a similar fashion, you may be better off in the long run by choosing the lower cost fund.
So let’s assume you are invested in a mutual fund (either in a taxable account or through a tax deferred account like an IRA or 401(k)) and the return for the year was 5%. If the fund’s expenses were 1.1% (which doesn’t necessarily sound like a lot), then your actual return is only 3.9%. However if that fund had an expense of 0.1%, then you’d make 4.9% return which is a 1% return difference from the first example I gave. But does making 1% less really matter?
You bet it does! Since I love to talk about compound interest, let’s look at the difference in compounding at a rate of 3.9% vs. 4.9% in the examples above. If you’re investing $100 per month, after 20 years at 4.9%, you’d have $39,262 and at 3.9% it would be $35,365, which amount to a difference of $3,897 over that 20 years. I don’t know about you, but I’m not about to let the fund company have 10% of my earnings for expenses if there is a lower cost alternative. And when your portfolio gets even bigger, like $500,000 or $1,000,000 then you’re talking about $5,000 and $10,000 respectively in savings per year in this example just by opting for a fund with lower expenses!
Mutual funds are required to disclose their expenses, so search the websites or look at their annual statement to see what the fees are. I have several different funds with Vanguard and they clearly publish the expense ratio for each fund on an information page about each fund. In fact lower fee investing is really what Vanguard is all about. They pioneered and perfected the index fund which has become the least expensive type of fund you can invest in. I’ll try to go into more detail about index funds and Vanguard in future posts. I get no money from Vanguard, but I can’t help but recommend them to anyone interested in investing simply because they are so affordable.
The biggest difference in the types of fees that funds charge is due to the type of fund it is: actively managed vs. passively managed/index funds. The actively managed funds will have more trades and more analyst and manager salaries to cover, which all adds up. With an index fund, the purchases and sales of the fund are all driven by the underlying index that the fund is tracking (e.g. S&P 500 index) which can be done with a smaller staff, hence lower costs. And the best part about it all is that actively managed funds have a very hard time beating the baseline index they are being compared against, so you usually wind up winning on both sides of the balance sheet; you earn more and pay less in fees. And that’s going to help you earn more money every year with even more compound interest!
Check on your accounts/funds and see if you need to make some changes to accounts that charge lower fees. Your account balances will thank you!