How Much Do You Pay For Your Mutual Funds?
As I wrote in a previous blog, we live in a world of uncertainty. It’s impossible to predict future stock prices no matter how fancy the purported methodology. But that’s no reason not to invest. Most of us need to grow our savings in order to keep up with inflation as well as to be able to fund the things we’ve been saving for in the first place. And although we cannot control returns, there are a number of factors we can control to maximize the likelihood that our investment portfolio will grow sufficiently to support all our future goals. A very important one is cost.
Lipper Research recently reported that the average annual expense paid by retail investors for mutual funds is around 1%. If a fund with a 1% annual expense were to earn 6% in a particular year, the fund would report and distribute 6% -1% = 5% to its investors. That may strike you as excessive. But compared to most hedge funds, which charge 2% annually together with an additional 20% on any profits, that 1% sounds positively benign. Then again, having to pay 1% each year will certainly add up, especially for a portfolio you may be managing for 20 years of your working life followed by another 30 years throughout your retirement. Suppose you were able to knock down that annual cost to 0.5%. On a $500K portfolio over those 50 years, with the additional savings reinvested at just a 5% return, you would accumulate (before taxes) another $550,000 before you pass away. That’s not small change.
Yet most investors do not consider cost when comparing mutual funds. And the mutual fund industry hasn’t helped. Many fund management companies have created multiple versions of the very same fund with different pricing structures. Let’s take an example from American Funds, a popular fund family. (Note that I am neither recommending nor disapproving any funds mentioned in this blog). There are no less than 12 different classes of their EuroPacific Growth fund currently sold on the market. And the annual expenses for each vary widely. Here’s the list (the data comes from Morningstar):
|Fund Ticker||Annual Expenses||Additional Expenses||Notes|
|AEPGX||0.83%||Front End Load: 5.75%|
|AEPCX||1.61%||Deferred Sales Charge: 1.00%|
|CEUAX||0.89%||Front End Load: 5.75%||For 529 plans|
|CEUCX||1.67%||Deferred Sales Charge: 1.00%||For 529 plans|
|RERAX||1.59%||For retirement plans|
|RERBX||1.57%||For retirement plans|
|RERCX||1.13%||For retirement plans|
|REREX||0.84%||For retirement plans|
|RERFX||0.53%||For retirement plans|
|RERGX||0.49%||For retirement plans|
What’s the difference between all these funds? None! They are all the same fund! You’re just charged different amounts primarily depending on who sells you the fund. The front-end load versions are designed for commission-based advisors, since it’s the load that pays their commission. The myriad retirement plans versions are for different retirement plan administrators. If your company’s plan includes this fund, and is big enough to have negotiated a good price with American Funds, it will likely include one of the fund’s lower cost versions. If not, too bad.
Exchange-traded funds (ETFs) with lower annual expenses might also be available to you through a brokerage account within your 401(k). But I would not recommend switching unless you are comfortable that the ETF’s target asset class and management strategy matches that of the fund you are trying to replace. Cost is important, but even more so is your allocation model.
The good news is that with the recent passage of the Department of Labor’s new fiduciary rule for retirement plans, fund costs are likely to drop, since the industry as a whole will be under pressure to better justify them. And perhaps those fund families with so many versions of each of their funds will quietly put some of them out to pasture. But in the meantime, you should pay close attention to the annual fees being assessed. Cost is one factor that is decidedly within our control and that will definitely impact the wealth we accumulate.