An investor fee is much like a hole in the bucket; the greater the fee, the bigger the hole in your retirement savings bucket.
The purpose of this post is to illustrate why comparing investment fees is essential when making investment decisions.
Table of Contents
Investor Fees
Employer Plan Fees
Some investor fees are unavoidable. Take, for instance, fees charged for the operation of your workplace retirement plan. In most cases, the larger the employer, the smaller the fee. Here are the 40lk plan fees in the first half of 2021, according to the National Association of Plan Advisors:
Large 401(k) plan fees: Annual fees for plans with an average range of 1,000 participants and $50 million in assets: 0.88%.
Small 401(k) plan fees: Annual fees for plans with an average range of 100 participants and $5 million in assets: 1.19%.
Financial Planner Fees
The 2019 average total advisory fee, including all underlying investment products of manager fees, is 1.17%. The range is between .1% to 3%. Here is the impact of those fees over 35 years, assuming $10,000 is invested annually and it earns the inflation-adjusted average of 8%.
Option A: 0.15% in fees
Ending portfolio value (net fees): $1,797,513.07
Ending portfolio value (gross): $1,861,036.27
Cost of fees: $63,523.20
Option B: 1.17% in fees
Ending portfolio value (net fees): $1,423,155.00
Ending portfolio value (gross): $1,861,036.27
Cost of fees: $437,881.27
Option C: 3% in fees
Ending portfolio value (net fees): $948,368.74
Ending portfolio value (gross): $1,861,036.27
Cost of fees: $912,667.53
Mutual Fund Fees
Management fees, whether paid as a mutual fund expense ratio or a fee paid to a financial advisor, typically range from 0.01% to over 2%.
Common Fee Types
Mutual Fund Fees and Expenses
12b-1 Fees
Distribution Fees
Sales Charge (Or Load)
Redemption Fee
Exchange Fee
Account Fee
Purchase Fee
Management Fee
Shareholder Service Fees
Total Annual Fund Operating Expense
Visit the SEC page Investor.gov Understanding Fees for the definitions.
Defining Index Funds and Actively Managed Funds
What is an Index Fund?
An “index fund” is a type of mutual fund or exchange-traded fund that seeks to track the returns of a market index.
What is an Actively Managed Fund?
Actively managed funds are overseen by a fund manager who's responsible for deciding what the fund should own. These funds carry higher expense ratios than index funds.
Comparing Index Funds and Actively Managed Funds
Investor fee percentages can be misleading. Take, for example, a 1% fee on your investments. Seems modest, right? That is until you realize that a 1% fee on a 4% return is a 25% fee on your gains.
That's why index funds with no or very low fees outearn most actively managed mutual funds over long periods of time. The image below, created by Index Fund advisors, reveals that from 7/1/2003 to 6/30/2023 (20 years), index funds outperformed actively managed funds 97.43% of the time.
If that doesn't make the case for the simplicity of index funds compelling enough, this will.
Index funds don't go away, but some actively managed mutual funds do. If an actively managed fund continues to attract investors, it will likely continue to operate. However, the poorest performing actively managed funds don't survive.
The data comparing actively managed funds to index funds over long periods of time only includes the actively managed funds that survive. They do not include the poorest performing actively managed funds. And as you can see below, it's not just a few.
Between half and two-thirds of actively managed funds do not survive and are not included in the 20-year comparison to index funds. This is called survivorship bias, a common practice in which managers merge or close funds. Poor results are essentially swept underneath the rug, either going away completely and/or replaced by another fund's performance record.
Comparing Index Fund Fees
An S&P 500 Index Fund is the same investment, regardless of who manages the index fund, with one crucial difference. The fees.
What follows is a comparison of S&P 500 Index Funds, an image created by the American Association of Individual Investors. As you can see, there is a significant fee difference between a handful of the funds, and zero added value accompanies a higher fee.
Investment Fee Calculator
The Ontario (Canada) Securities Commission program Get Smarter About Money created this simple investment fee calculator.
See for yourself the impact of fees. To help get you started, consider that the inflation-adjusted average rate of return over time is 7-8%.
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