The fee ate my performance

by Manshu on October 22, 2009

in ETF,Mutual Funds,Opinion

Last weekend, the WSJ had a great piece about investors overlooking mutual fund fees. It was a good piece that illustrated how a lot of professional and retail investors don’t take into account fees while making decisions on which mutual funds to buy.

I think fees and expenses are one of the most important factors when it comes to buying a mutual fund or ETF. I feel this not only because of the cost involved, but also because lower fee shows honesty and / or efficiency (at least to me).

I believe that most mutual funds belonging to a particular category should have similar expenses. Therefore they should charge about the same to their investors. If there is a difference, then either one fund is more efficient than the other, more honest and willing to leave more money on the table than the other or both.

I simply don’t buy the idea that better performance should mean higher fee because I am not convinced that any one fund is really that much better than another in its category in the long run. I believe in this strongly and therefore look at fees carefully, but for others who find it difficult to give importance to fees because the numbers are really small like 0.5% versus 1.0%, the article states a couple of ways to do this:

Dollarize your expenses: The article states that if you take a look at your fund’s expense ratio and multiply that percentage with your holdings – you get the amount that you will pay in fees. If you were to write a check for this amount, how would you feel? Would you feel the performance was worth it?

I feel this is a pretty powerful way of taking fees into account. I haven’t done this for mutual fund fee, but I have done this with credit card interest. One Sunday, a couple of years ago, I sat down and totaled all the interest I had paid on a particular credit card.  The amount was just shy of what I used to earn in a month at that time. I was stunned. Although the amount was spread over two and a half years, it struck me that I had almost worked a month for free to use this credit card. If someone had told me I’d do that when I was applying for the credit card, I would have called that person crazy. That figure is still in my head and acts as a very powerful disincentive from using a credit card.

Shadow portfolio: The article states that another thing you could do is to create a shadow portfolio with low cost funds in the same proportion as the funds you own. This will probably work but involves a lot of work and I don’t fancy many people actually taking the trouble to do that.

I think mutual fund fees and expenses are a big factor on how a portfolio performs and there is no reason investors should pay more for a particular fund if they can get a similar cheaper alternative.

{ 3 comments… read them below or add one }

Mark Wolfinger October 22, 2009 at 6:06 am

Regardless of whether MF fees are consistent with those of their competitors, I would go as far as to say that the fees are simply too high. I go even further and say that buying mutual funds is a very bad investment idea.

And buying funds with a front-end load is making the decision to sacrifice your own financial future to provide a living for your mutual funds salesman.

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Manshu October 22, 2009 at 4:18 pm

Do you think all mutual funds are bad? Even the index funds?

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Mark Wolfinger October 23, 2009 at 5:15 am

I was referring to traditional mutual funds.

No. I prefer ETFs. There seems to be some current discussion that some of these funds are not what they are supposed to be, but that aside, UN-LEVERAGED ETFs and index funds are the good guys in the fund industry.

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