Why I hate Mutual Funds- Part 1: Wealth-Killing Fees
WHY I HATE MUTUAL FUNDS AND YOU SHOULD, TOO
1. WEALTH-KILLING FEES AND EXPENSES
Mutual funds are expensive. Many costs are built into their share prices (Net Asset Values), but these are not always apparent. Shareholders effectively give fund managers an open expense account to pay for securities trading costs, market impact costs, spread costs associated with buying or selling securities at less than favorable market prices to fill shareholder orders, and more. It adds up.
You might be paying $64,000 without knowing it
Let’s take an example. Suppose we have two mutual funds each with the same average annual return of 7%. Fund A charges 0.5% in fees. Fund B’s fees are 1.5%. If you invest $25,000 for 35 years with no additional contribution, Fund A produces a net return of 6.5% or $227,000. Fund B generates a net return of 5.5% or $163,000. In other words, it costs $64,000 to be in Fund B — a 28 percent surcharge.1
Can you imagine investing $25,000 and agreeing to pay an average of $1,829 a year extra, beginning the first year, to be in Fund B? You’d never do it. Yet, the typical active mutual fund charges fees of 1% or more.
The expense story gets worse
A mutual fund’s expense ratio captures only the visible, or reported, costs of owning shares of the fund. But funds incur a host of invisible costs, such as trading costs associated with changes to portfolio holdings.
Trading costs are in addition to and often run higher than reported expenses. One study of mutual funds found the average annual expenditures on trading to be 1.44%, the average expense ratio to be 1.19%.12 Now if a 1% increase in fees costs a $25,000
investment $64,000 over 35 years, as noted above, then imagine the cost of an additional 1.44%.
It’s unfathomable to me why anyone would invest in something so expensive. True, $11.90 (1.19% expense ratio) and $14.44 (1.44% trading costs) incurred on every $1,000 invested doesn’t seem like much. But remember, that’s $26.34 on every $1,000 every year and compounded as the years go by.
And there’s more.
Advisor fees, sales fees, redemption fees, and more
Investment advisors add an annual fee to supervise your account, often 1% or 2% of your account balances. Some mutual fund companies charge sales fees (or loads), which are assessed each time you purchase fund shares. Need to redeem some shares? There may be a charge for that. And many funds charge account maintenance fees to administer your holdings.
There’s not enough room here to discuss all the fees and expenses associated with owning mutual funds. The point is, they’re excessive.
“Investing $5,000 a year for 40 years and earning a 6.5% annualized return results in nearly $880,000. Investing the same amount over the same period but earning a 5.5% annualized return results in about $680,000,” says The Wall Street Journal “So in this case, losing 1 percentage point of annualized return due to bad trading would cost you 23% of your potential final sum.”
MARK A. J. GUILLIATT, CFP