Mutual Fund Management Fees: How much is too much?
16 July 2006For those of us whose investments are in mutual funds instead of individual stocks, a primary concern is going to be the annual management fee charged by the fund. Every mutual fund charges some percentage of the assets for a variety of different fees. Management fees usually constitute the bulk of these - they average between .5% and 1% of the annual assets, and are used to pay for fund managers whose brilliance in investing is supposed to increase annual returns well beyond this amount.
However, there are often also fees for administrative costs and even for marketing the mutual fund - so you’re in essence paying to get other people to give more assets over to the fund managers. With these fees tacked on, many funds can have fees exceeding 2% a year.
How much difference does this really make? Over time, it can be dramatic. I ran a simple spreadsheet assuming a $10,000 initial investment, growing 8% a year, in two hypothetical funds - one with a one percent fee, one without it. Twenty years later, the fund with the fee was worth $35,655 - versus $43,157 for the fund without it. Those little fees add up, and even though it’s a small amount each year, it’s money that you aren’t earning compounded gains on. Over the long haul, it makes a big difference towards your retirement.
So how do you avoid these management fees? One solution is shopping around - look at other similar funds, read the fine print, and see if you can’t find a comparable fund that costs you less. Why should you be paying for the fund to advertise itself, among other things?
Another solution is to rely on index funds - funds that try to buy stocks to roughly match their assets to some established index such as the S & P 500. There are indexes related to virtually any kind of asset you want to own - from real estate to nanotechnology stocks. And because there is very little decisionmaking involved, the fees are often extremely low - generally around .25% of assets. That makes it very easy to get extra return on your money by simply by avoiding fees. And in fact, it might be a better investment anyway - an oft-quoted statistic is that only 20% of mutual funds beat the market’s returns (see here). You might be better off in those index funds anyway, regardless of fees.
For discussion of this post visit the Free The Drones Forums here.
One Response to “Mutual Fund Management Fees: How much is too much?”
July 16th, 2006 at 8:21 pm
Carnival of Investing…
Welcome to this week’s edition of the Carnival of Investing. I’m sticking with my usual method of hosting a carnival — listing a summary of each piece with the author’s reason for submitting the post to the carnival (for those…