The research is clear. Fees are the biggest drag on investment returns. Advisor fees, commissions, annual fees, exit fees—all reduce an investor’s net. The best investment choice can see its value eroded by explicit and implicit fees.
Many investors opt for pooled funds (mutual funds, ETFs, annuities, separately managed accounts, even private equity funds), and these all have internal fees. We call this the expense ratio. It is measured as a percentage of the overall portfolio and occurs annually. Most of the fee goes to the fund manager but also covers administrative costs. Some ETFs have fees less than 0.10%, while some private equity funds have annual fees over 2.0%. It’s a wide range.
Earn 10% on your mutual fund in your 401k? Expect that number to be net of whatever the fund managers are charging. Maybe the underlying fund earned 11%, but 1% was carved out to pay that annual fee. The higher those expense ratios, the lower the net return. And this is the reason it is so important to pay attention to the expense ratios.
Where can you find this number? Look in the prospectus for details on the fees. You should be able to find this document on the fund website. If the fund is in a 401k, it is probably in a tear sheet given to participants. You can look on sites like Morningstar.com for this information. If you are in a private fund, the fees should be in documents given to participants. If all else fails, call and ask, “What is your annual expense ratio?”
There are nearly 10,000 mutual funds, about 5000 US ETFs, and countless private equity funds. There is a lot of overlap so it makes sense to find the fund that fits your needs but also has the lowest expense ratio of any of its peers.
And many mutual funds offer a variety of share classes. Each fund is identical, as far as the underlying securities, but varies only by those expenses. Check the funds in your 401k and see if there are lower cost alternatives. If so, ask your administrator/trustee to see if such an option is available.
Expense ratios have been declining in recent years as competition has heated up. That’s good for investors. Imagine having a share class with a 0.75% expense ratio, while your friend owns the same fund with a 0.50% expense ratio. Think about the difference in 0.25% accumulated over 30 years and you can understand how important it is to focus on this fee. That difference could be in the thousands!
Certainly, there are other fees you might encounter, but internal expense ratios are some of the biggest. Look for that number and choose the lowest cost alternative available. There are real dollars at stake!
