Chart of the Week: Why Investment Fees Matter!
May want to find a way to cover up the ending balances after 30 years.
Question: Two investors start with $100,000 and earn a 6% return per year for 30 years:
- One chooses a low-cost mutual fund with a cost of 0.25% (a.k.a. expense ratio) that is applied to their invested assets each year. Note that many index funds have even LOWER expense ratios).
- The other chooses a higher-cost mutual fund of 0.63%, which is apparently the weighted average expense ratio for U.S. mutual funds. This is also applied to their invested assets each year.
How much MORE does the investor with the low-cost mutual fund have at the end of 30 years?
Answer: Over $57,000! So, a difference of .38% in fees (0.63%-0.25%) leads to a significant difference in what each investor earns.
This is a super important message. Just as we discuss the compounding effect on your investment returns, you also need to be aware of the compounding effect of fees. A small difference in fees really adds up when compounded over a 30 year period. Focus on the fees!! Unlike most fees you pay for financial products, this one is invisible to most investors. You don't send in a check or get a bill for the fees incurred in a mutual fund. Instead, the investment manager is kind enough to take it directly from your investment account with nary a notice. This is why so many people think "oh, my mutual fund has no fees!"
About the Author
Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.
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