Intelligent Design

John McMillen | Portfolio Manager

Learn what matters - and what doesn't - when building a sound investment strategy.

Fees Really Do Matter

July 2008

A basic tenant of successful investing is to be acutely aware of all fees being incurred.  In today’s investment marketplace – with an endless number of options and less-than-clear fee disclosure – it is often difficult investors to truly compare apples to apples.  However, this is not the case with most passively managed investments, especially those with an objective to track a major index such as the S&P 500.

Listed below are the Annual Report Net Expense Ratio, 10-Year Total Annualized Returns and 10-Year Standard Deviations for five well-known mutual funds tracking the S&P 500:

Given that the objective of all five funds is to replicate the performance of the S&P 500 index, all of the funds share the same basic level of risk (measured by the standard deviation) as the benchmark they are tracking. The investment returns of the funds, however, are another story entirely: The high-fee funds offered by Wells Fargo, Morgan Stanley and J.P. Morgan did a less-than-stellar job of capturing the S&P 500’s return, netting only between 65% and 68% of what the index delivered. In contrast, the low-cost options from Schwab and Vanguard captured 92% and 98%, respectively, of the benchmark return. It is easy to see the inverse relationship between fees and performance.

Though it would seem that all rational investors would obviously choose the low-cost offerings over their high-fee counterparts, this is not the case: The three funds from Wells Fargo, Morgan Stanley & J.P. Morgan have a combined $3.3 billion in assets, which nets those firms a combined weighted average additional $36 million annually above the fees charged by Schwab and Vanguard.

Fees should always be considered based on the value derived, and it is hard to think of what additional value any of the high-fee index funds are delivering for their additional $36 million dollars annually. Those are very real dollars that almost all investors would agree could be put to better use than enriching the fund provider while delivering sub-par performance. 

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