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Mutual fund fees may be the number one cost criminal in your 401k. They steal your hard-earned retirement dollars so quietly that they almost go unnoticed.
When 401kFundAdvice begins an analysis on your investment account, we see that this is often one of the greatest areas for improvement in portfolio construction.
The good news is mutual fund costs have become more and more of a focus over the last few years, so costs have come down some.
Studies show that there seems to be very little association between mutual fund investment performance and the cost you pay for it. In fact, it appears that in many funds, there are so many stock positions that many managed funds mirror unmanaged index funds without the benefit of unmanaged funds’ lower price tag attached.
So, when comparing expensive funds versus their cheaper competitors, the cheaper mutual funds generally win. Do you want to know why? They’re cheaper.
You see, mutual fund expenses are attached to the price of a fund. They burden mutual fund performance regardless of whether the fund makes money or loses money. Let’s take two funds that are equal in every way, except for the expense ratios, and look at the long-term effect on performance.
| Brock's Account | Cade's Account | |
| Beginning Balance | $100,000 | $100,000 |
| Gross Return | 10% | 10% |
| Expense Ratio | 1.5% | .5% |
| Net Return | 8.5% | 9.5% |
| Years Invested | 20 Years | 20 Years |
| Total Retirement | $511,204.61 | $614,161.21 |
From the above example, the only difference is the mutual fund expense ratio. Brock paid 1% more for his mutual fund than Cade did. Assuming the same gross returns for both funds, Cade retired with more than $100,000 than Brock. This telling example illustrates the importance of controlling mutual fund costs.
Of course, the additional cost of managed funds is believed to be buying the mutual fund owner something. More management. Superior stocks. Someone overseeing your investment. Again, most studies have shown that is not the case. Cheaper, less managed funds out-perform their peers primarily because they’re cheaper and less managed.
Why do mutual funds charge an expense ratio to the funds in the first place?
There are at least three components to mutual fund expense ratios. They include:
Investment Advisory Services. Investment advisory costs generally make up the largest component of mutual fund expense ratios, as it requires a good deal of resources to determine which stocks or bonds should be bought by the fund.
12b-1 Fees. These are interesting little critters that eat away at your retirement future. 12b-1 fees are essentially tack-on fees that cover promotion materials, advertising slicks, television commercials and the like. Yes, you help fund the mutual fund commercials with cartoon-like characters designed to get more of your money. These fees can be as high as 1% by themselves. Generally, they charge a rate of ¼ of 1%
Administrative Costs. These costs are fairly self-explanatory. Personal service lines, internet websites, forms and the like make up this group.
To summarize, controlling mutual fund costs is extremely important. There are a lot of good mutual funds out there doing what they do for a good price. Don’t waste your money on expensive funds with large mutual fund expenses.
One Of The Greatest Benefits of Hiring 401kFundAdvice is Our Ongoing Commitment to Control Costs Within Your Investment Portfolio.