High-fee mutual funds will slice away at your retirement. In this post I will demonstrate how, over the long-term, high expense ratios and load fees will cost you big time.
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High Mutual Fund Fees Will Cost You Big
Anyone who has investments in mutual funds should be aware of the fees that they are paying. For an old friend of mine, I may have just saved his family $370,000.
Before we get into the story, check out my post about the importance of the emergency fund. The emergency fund is the foundation of personal finance.
If you are just starting out with investing and personal finance – start there.
Now, back to my friend.
This week was an opportunity to help an old bud of mine. We’ll call him Dale. I’ve always wanted to have a friend named, Dale…so, this makes the story that much more interesting!
Dale, is a guy I’ve known for decades and we’ve recently reconnected. The last couple of days we’ve started discussing personal finance and I got the chance to share some things I’ve learned over the years.
Lucky for me, he happens to have some experience with compound interest…so, making the case for a lower-fee solution was easy.
It wasn’t hard for me to say, “Dale, high mutual fund fees will cost you big!”
Proper Planning Prevents Poor Performance
These were the 5 words my 10th grade Spanish teacher used to say when I had some excuse to spew in class. I don’t remember much from that class other than those profound words. They ring true in this story.
You see, Dale was introduced to his current financial advisor by another friend of his. Yes a “mutual” friend!
Now, making the mature step of investing money for the long-term is never a bad thing. However, there are always better ways to do things…ie performance. This mutual friend had good intentions for Dale…but, what Dale didn’t realize is that high mutual fund fees can (and likely will) produce poor performance.
I’ll say it again. Proper planning prevents poor performance.
After I had a chance to look over his portfolios, there were fees galore! Some of the funds he purchased from his financial advisor had 5.75% front-load fees. What that means is for every $100 that Dale gave his financial advisor, only $94.25 was actually invested.
Said another way, one day you have one hundred bucks and then the next day it’s chopped down to $94.25. So, where did the other $5.75 go? Did it buy a latte at Starbucks? No. That money was paid to the advisor for his/her services.
Now, here’s the rub…Dale had no idea that there are much cheaper alternatives, and I mean a lot cheaper. We’ll go over that in a minute.
These days, there is really no reason to own high-fee passive mutual funds. You can have practically the same portfolio for literally a fraction of the cost.
The low-fee ETF industry has slowly been chipping away at mutual fund assets for years. So, let’s do a hypothetical comparison of 2 portfolios with $50,000 each.
The portfolios will consist of large-cap U.S. stocks. The first portfolio will be a mutual fund (like Dale) that has a 5.75% front-load fee plus an annual .75% expense ratio.
The 2nd portfolio will have zero front-load fees and an annual expense ratio of just .05%. By the way, these are real life examples of available fee structures (products) for individuals.
Portfolio 1: High Fees
As you can see in the below image, the contribution was $47,125 because of the 5.75% front-load fee. Also, because stock market returns historically are 10% per year, we will lower that rate by .75% due to the expense ratio.
The total value after 30 years leaves this portfolio at a princely sum of $669,722.26. You may say to yourself, “that’s not bad!” But, before you do, check out portfolio 2.
All charts were generated at investor.gov.
Portfolio 2: Low Fees
Now, let’s compare portfolio 1 to a portfolio invested in a low-cost ETF with practically the same exposure (large-cap U.S. stocks). This fund will have zero load-fees and a much lower expense ratio of .05%.
The contribution was left at $50,000 and the annual compounded return was set at 9.95%. With just a little bit of effort, the 2nd portfolio grew an extra $190,928… talk about how proper planning prevents poor performance.
How Much Does 2% Between Friends Cost?
By now you should be getting the point that there are better fund options for investors. As I looked over yet another of Dale’s retirement accounts, he was pleased to show me that he owns a no-load fee mutual fund.
For a moment I got excited. This happened to be another U.S. large-cap stock mutual fund. The account was worth right around $50,000.
He even remembers his other financial advisor praising how this mutual fund had no load fees!
Dale thought he was doing a great job. After all, there’s no upfront fees right? Well, not so fast. The expense ratio is 2.08% annually.
Now, that may not seem like much because after all it’s only 2%! But, when it comes to compounding it makes a world of a difference. As I explained to my friend, there are ETFs with practically the same holdings (stocks) and charge .05% annually.
This is a great thing, as I told Dale, because in his case he could be looking at $370,000 extra at retirement time. Let’s look at another example:
The chart below shows how much a $50,000 investment will grow over 30 years. The middle line (red) shows compounding at 10% annually, while the lower line compounds at 8%.
The 2% difference over three decades could theoretically cost Dale ~$370,000.
The cost of high mutual fund fees is staggering.
Bottom line: there is no reason to pay high mutual fund fees for passive investments in this day and age. A little proper planning will undoubtedly improve your performance.
Hello. My mom at 70 years old recently lost her job at a non-profit. She has a 403b that must be rolled over. She was terminated June 7th. Can you give advice as to where to rollover- how long I have to help her get it done and what kind of ira we should do! I love pfkid!!! Thanks.
Hi J –
First of all, I’m sorry to hear that your mother lost her job. That is never fun – just remember to build her up and stay positive.
Depending on the previous employer, you may be able to keep the account with their plan. You’ll need to check with their human resources dept. to make sure. But, you can also roll over a 403b into an IRA account. I will assume this is a traditional 403b account and not a Roth 403b. YOU need to make sure if it is a traditional or Roth, however.
If you’ve determined that you want to do a rollover into a tradition IRA, make sure to do a “direct rollover”, which means the entire account is rolled over into a qualified account. You don’t want to incur federal tax withholdings. This way it is a clean transfer from the old account to a new account (or existing account if she has one). Anytime you have qualified funds sent directly to you, like via a check, it’s called an indirect-rollover. If this happens, there is a 60 day rule where those funds will have to be deposited into a qualified account or else you’ll have to pay taxes and/or penalties.
Does your mother have an IRA currently? If she does, you can simply rollover into that account. If she does not, you’ll need to open one. Fidelity and Interactive Brokers are very good options, in my opinion. (if it was my mother I’d choose either of those).
Lastly, for traditional IRAs, at the age of 70.5, you’ll need to look into an annual RMD (required minimum distribution). That is the minimum amount that must be withdrawn each year. If funds are in a Roth IRA, there is no RMD requirement until after the death of the owner.
-pfkid