Many of us are performance junkies. RBI, mpg, mph, Kbps… we focus on the fastest, the biggest, the best. As investors, we tend to gravitate toward mutual funds with the highest returns.
And why not? Even though we’ve been told repeatedly that past performance is no guarantee of future results, what other facts are there to go on?
Most independent advisors would answer in chorus: “Fund fees!”
“The most important element of fund-picking [is] low fees,” says SmartMoney magazine. Turning a blind eye to fees is one of the biggest mistakes mutual fund investors make, according to a leading fund analyst quoted in U.S. News & World Report.
For example, consider two investors with $10,000 each. The first investor puts his money into Fund A, which charges 0.5% in annual fees. The second investor chooses Fund B, with expenses of 1.5%. Let’s say both funds earn 10% a year. In 20 years, the low-fee investor’s return is roughly $60,858, while the investor paying higher fees receives only $49,725 – 18% less.
But isn’t it possible for a fund that charges more to outperform similar funds that charge less? Sure, but it’s not likely. Over the past 10 years, according to Vanguard, funds with lower expenses have outperformed funds with higher expenses in almost every category.
That’s why the U.S. Securities & Exchange Commission says, “Independent studies show fees and expenses can be a reliable predictor of mutual fund performance.” Just not in the way you might have thought.
The takeaway for investors:
- Don’t simply invest in the funds with the lowest fees, regardless of category. If you do, you’re likely to end up with a portfolio of S&P 500 index funds. Know how you want your assets to be allocated.
- Within each category, search for funds that have the lowest fees and have performed better than average.
- Before you invest in any fund, be sure its investment goals and risks are a good match for your preferences.
