How much do fund fees/expense ratios matter? March newsletter

[jfoxcpacfp]

Our (barely) March newsletter went out today. This month, the central focus is on mutual fund fees. Do they really impact your long-term retirement growth? In general, I think not, and explain why. The full roundup this month includes:

• The Irrelevance of Fees (Expense Ratios) in Your Investment Portfolio


• Expense Ratio Exercise: Which Portfolio Wins? (YouTube Vlog)


• How to Stack Education Savings (Doctor Dilemma on how to save for your children's education)


• For something fun, Robyn has a great before and after project (with pictures) of transforming an unneeded formal dining room into a really cool library


• Photos from the WCI Financial Literacy Conference

Click here if you'd like to receive your very own newsletter in your inbox every month!

[CordMcNally]

As far as the debate goes regarding active vs. passive and the pursuit of optimum growth for long-term wealth, I think the data has been pretty clear that passive investing has outperformed active investing and will almost certainly continue do so. With that assumption, that means that lower expense ratios (as found with most passive investing as compared to active investing) are usually inherently better. There are always exceptions to every rule. That isn't to say that high fee funds are all bad and some people's retirement plans only contains awful funds with awful expense ratios and the only other alternative is not investing.

 

Fees can certainly inhibit growth long-term and when taking compounding into the equation, the amount "lost" to fees can be remarkable.

 

Note: I haven't had a chance to watch the VLOG yet.

[VagabondMD]

I would never say that I agree with your point re: expense ratios in a pro-Boglehead public forum, but I just did. It gets really silly when people talk about shifting between Vanguard, Schwab, and or Fidelity over a drop of one or two basis points. I have failed to meet anyone whose financial plans have been thwarted by a few basis points, but no doubt somewhere out there, that unicorn may exist.

I am not saying that one should not be fee-conscious and pay as low as reasonable price as one can to get excellent service and value, but sometimes the tail can wag the dog. For the record, I do own some active funds, and I guess I am out of the closet there, too.

[Hatton]

I also hold some active funds.  Probably an age thing.

[Hatton]

I agree with the chasing a few basis points is silly.  Never take a capital gain without a very good reason.

[Donnie]

It's not really a matter for debate.  You should seek the highest risk-adjusted return possible for a given asset class.  If an actively managed fund can deliver alpha then you should be willing to pay fees in an amount less than alpha.  Can you or anyone else determine whether a manager is delivering alpha?  Probably not.  You are left then with passive index funds.  The only thing differentiating the same index funds is the amount of fees.  You should then choose the funds with the lowest fees according to your asset allocation.  The end.

[startupdoc]

Fund fees matter when all else is equal. To what degree?

At what point does the cost difference between two funds matter? 1 basis point? 10? 50? 100? I think some mathematical examples would help.

[jfoxcpacfp]

startupdoc wrote:

Fund fees matter when all else is equal. To what degree?

At what point does the cost difference between two funds matter? 1 basis point? 10? 50? 100? I think some mathematical examples would help.

Click to expand...

See the vlog. Michelle back-tested the actively-managed fund portfolio we had used for several years before we built a new portfolio of index funds and compared it to what we're using now. I didn't even bother to check before asking her to run the report and record the video - I knew the results would be about the same. (fwiw, we changed to index funds only because of the perception of so many physicians who read the finance blogs that they would be better. It was a PITA to do so.)

Over the long term, a well-diversified portfolio of quality mutual/etf funds, whether active or passive, are going to have similar results. I'm weary of hearing how investors are giving up tens of thousands of dollars in growth (even hundreds of thousands according to some) by using one strategy or the other.

The point I'm trying to make is that the math is what causes problems here. There is not a straight line that goes from investing in low-cost funds to improved results. I can't give you an answer to your question because there is no answer. Getting better investment results - which I will presume we are all in favor of - is a far more nuanced process but the argument is always presented mathematically. If investing in low-cost portfolios delivered such staggeringly better results, I would expect to see a lot of real-life examples floating around. I see a lot of hypotheses and predictions, but not results.

I worry that the heavy focus on discussing fund fees leads many unlearned investors in the wrong direction. Fund fees are not what they should be worrying about. As I said in the article, choose funds with reasonable fees after you've put the other steps (you know, the ones that really matter) in place. And then move on...quit obsessing over costs.

[Donnie]

jfoxcpacfp wrote:

Over the long term, a well-diversified portfolio of quality mutual/etf funds, whether active or passive, are going to have similar results.

Click to expand...

This is the problem with this line of thinking.  There is no way to figure out whether an actively managed fund is "quality" or not.  Funds outperform benchmarks until they don't.  The issue with active funds is not the fees, it's the underperformance.

[Complete_newbie]

All fine and dandy but what is reasonable fees exactly? You didn't define it. This can be achieved with optimization analysis (I'm too lazy to do it).

If you say that some actively managed funds vs index funds did "about the same" "over the long haul" then there has to be fees at which equilibrium would be achieved. That way you can have data driven basis for the claim.

To me "about the same" etc don't mean much. Without provenance of data, I can't trust the results you speak of.

[jfoxcpacfp]

Donnie wrote:

This is the problem with this line of thinking.  There is no way to figure out whether an actively managed fund is “quality” or not.  Funds outperform benchmarks until they don’t.  The issue with active funds is not the fees, it’s the underperformance.

Click to expand...

I guess it depends on your definition of quality. That doesn't mean we think we can predict results but it does mean that we vet managers and the characteristics of the fund - including fees and turnover. Not to attempt to outperform but to avoid long term under-performance. How many schedule D's do you think I've seen in my life that have consistently under-performed over the long term? I can promise you the reason was not high fees.

[triad]

Donnie wrote:

It’s not really a matter for debate.  You should seek the highest risk-adjusted return possible for a given asset class.  If an actively managed fund can deliver alpha then you should be willing to pay fees in an amount less than alpha.  Can you or anyone else determine whether a manager is delivering alpha?  Probably not.  You are left then with passive index funds.  The only thing differentiating the same index funds is the amount of fees.  You should then choose the funds with the lowest fees according to your asset allocation.  The end.

Click to expand...

I'm actually kinda shocked any financial advisor on this site would suggest otherwise.

[CordMcNally]

jfoxcpacfp wrote:

Donnie wrote:

This is the problem with this line of thinking.  There is no way to figure out whether an actively managed fund is “quality” or not.  Funds outperform benchmarks until they don’t.  The issue with active funds is not the fees, it’s the underperformance. 

Click to expand…

I guess it depends on your definition of quality. That doesn’t mean we think we can predict results but it does mean that we vet managers and the characteristics of the fund – including fees and turnover. Not to attempt to outperform but to avoid long term under-performance. How many schedule D’s do you think I’ve seen in my life that have consistently under-performed over the long term? I can promise you the reason was not high fees.

Click to expand...

To me, the whole reason to actively invest is to outperform whatever index you're looking at. If your goal is to avoid long term under-performance then that defeats the purpose of active investing. Besides, it's hard to do many things long term with actively traded funds because a large majority don't survive long term.

[jfoxcpacfp]

triad wrote:

Donnie wrote:

It’s not really a matter for debate.  You should seek the highest risk-adjusted return possible for a given asset class.  If an actively managed fund can deliver alpha then you should be willing to pay fees in an amount less than alpha.  Can you or anyone else determine whether a manager is delivering alpha?  Probably not.  You are left then with passive index funds.  The only thing differentiating the same index funds is the amount of fees.  You should then choose the funds with the lowest fees according to your asset allocation.  The end.

Click to expand…

I’m actually kinda shocked any financial advisor on this site would suggest otherwise.

Click to expand...

I'm not looking for alpha. I'm looking to keep clients from under-performing what is possible to achieve in the market. I'm just disputing the gospel that the only way to do that is with passive funds. As I said in the article (which I'm sure you read), I'm agnostic about which way is better. It really doesn't matter.

[jfoxcpacfp]

CordMcNally wrote:

To me, the whole reason to actively invest is to outperform whatever index you’re looking at. If your goal is to avoid long term under-performance then that defeats the purpose of active investing. Besides, it’s hard to do many things long term with actively traded funds because a large majority don’t survive long term.

Click to expand...

I knew this would be fun.