Do not ignore fund fees.
One of the great tricks of finance is how quickly seemingly-small percentages can add up. The difference between 3% and 4% mortgage rates, for example, can mean hundreds of dollars or more per month in extra interest payments. The same is true when it comes to the fees attached to mutual funds and exchange-traded funds (ETFs). A 0.5% annual charge may not seem like a lot of money, but it can take a big bite out of your investment returns given enough time.
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This is why a new Morningstar study on fund fees is welcome news. As it turns out, they’re going down.
According to the company’s annual study on fund fees, expense ratios have been falling over the last two decades. In 2022, the average asset-weighted expense ratio across all mutual funds and ETFs was 0.37%. “This is less than half of what investors paid in fund fees, on average, in 2002,” Morningstar’s Bryan Armour writes.
Even better, the main driver of this appears to be consumers themselves. Morningstar’s research finds that most of this dip has been caused by investors seeking out low-cost funds.
What Are Expense Ratios?
Mutual funds and ETFs are portfolio investments. This means that any given fund is an investment that you can buy shares in and it, in turn, holds a bundle of underlying assets that drive the fund’s returns. For example, you might invest in a fund that invests in all the companies that comprise the S&P 500 or one that focuses solely on technology stocks or real estate. The fund’s performance is based on the collected gains and losses of its portfolio, and each shareholder receives a proportional amount of those returns.
In general, these are excellent long-term investments, because the portfolio structure smooths out the volatility of more speculative assets. For stocks in particular, funds allow you to capture the gains of the market overall without the risk of having to pick individual winners.
On the back end, a fund is run by a management team. This is the group of financial professionals who (among other duties) chooses investments, trades assets, distribute earnings and manages tax efficiencies. In exchange for this work, they charge a management fee called an “expense ratio.” As we wrote on the issue, expense ratios are “expressed as a percentage of an investor’s total assets with the fund and automatically removed from their account each year. The smaller the expense ratio, the more money an investor keeps to him or herself. Meanwhile, a heftier expense ratio can significantly eat into future returns.”
So, for example, say your ETF has a 1% expense ratio. This means that each year the fund will take 1% of your portfolio’s overall assets as payment for management and services. The more often and aggressively it trades assets, the higher the expense ratio will typically be.
Fund Fees Can Take a Big Bite Out Of Returns
In absolute terms, expense ratios are very small numbers. On average, you’re likely to pay 0.3% or 0.4% for a managed ETF or mutual fund. But just because these numbers are low doesn’t mean they are insignificant.
In 2022, The Pew Charitable Trusts looked into just how much mutual fund fees can affect the savings of retirees. The organization’s report compared the management fees of 401(k) and IRA programs, finding that even a small difference in fee structure can cost investors billions of dollars over time.
Or, consider this from the perspective of an individual investor. Say that you are 40 years old with $100,000 in a retirement account. Each year you add $6,000, putting in $500 per month from your paycheck. You have the entire pool of money invested in an S&P 500 index fund with the market’s approximate 10% annual return and a 0.4% management fee. By age 65, your account would be worth approximately $1.6 million and you would have paid $142,000 in fees.
This is why Morningstar’s findings are such good news. According to the report, average fund fees fell from 0.40% in 2021 to 0.37% in 2022. This drop seems small, but using our example above, it would be the difference between paying $142,000 in total fees versus $132,000.
The point, then, is this: Do not turn a blind eye to fund fees. Even a seemingly tiny difference of 0.01% here and there can add up to thousands of dollars over the years you will have this money invested during. This is even more important given that you probably aren’t getting much for that money. Higher fees typically do not relate to better performance, according to Vanguard, for a mutual fund or ETF and, in fact, often correlate with worse performance than more lightly managed, low-fee portfolios.
Average management fees for mutual funds and ETFs have dropped from 0.40% to 0.37%. This may seem minuscule, but it could save your retirement fund thousands of dollars in the long run.
Mutual Fund and ETF Tips
- A financial advisor can help you build a comprehensive retirement plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Mutual funds and ETFs mirror each other in a lot of ways, and this is by design. ETFs were built to essentially be mutual funds on the stock exchange. But there are a few key differences that can help you determine which is right for you.
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