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The Real Truth about Mutual Fund Fees












This discussion about mutual funds is different than almost
any information available on the web.  I will debunk some of
the oldest myths about mutual funds, and probably burst a
few bubbles for the low cost motivated do-it-yourself
investors.  

Much is written about mutual fund fees and promoted by no-
load fund marketing efforts.  Vanguard Group, one of the
largest fund families in the country, has built a whole
company on this idea.  It has been the mantra of Jack Bogle,
the company’s founder, for many years.  My hat is off to Mr.
Bogle’s achievement, but I believe it is a sales pitch more
than a reality.  A sales pitch that many people fall for as it
turns out.  In the October 5th, 2010
USA Today it states,
"Vanguard is now the largest mutual fund company.  It would
be tough to argue that Vanguard won its following with white-
hot performance."  Vanguard's largest fund at this time is the
Total Stock Market Index Fund.  The 10 year average return
on the fund is .3% a year.  The reason so many people buy
this argument is that, on the surface, it seems to make
sense.  Using Vanguard’s Fund Comparison calculator
promotes this myth.  You can find it here:
https://personal.
vanguard.com/us/funds/tools/fundcomparison. This
calculator will compare the costs of a Vanguard Fund to
another fund.  Since Vanguard’s funds have low expenses,
they typically come out on top of this comparison.  Since
you are a “smart investor” says Vanguard, it’s easy to see
that Vanguard should be your choice.  A report released in
2004 by Andrew Clark at Lipper Analytical Services, shows
there is no truth to this supposedly “smart” conclusion.  Mr.
Clark found two very interesting things…  There is no
statistical difference in performance between high and low
fee funds and past history is not a very good predictor of
future performance.  (In fact, in some categories, high fee
funds outperformed lower fee funds.)

Let’s look at the main premise of this idea...  Cheaper is
better.  When you go to buy a new car, are you looking for
the cheapest car on the car lot?  Based on the main
premise, that would be a “smart” move.  Understand this is
different than shopping different dealerships for the best
price.  That would be an apple to apple price comparison.  
Comparing these different funds on cost alone is not the
same and is not “smart.”  It might make you feel better to
pay less of a fee, but it doesn’t mean you will end up with a
higher return.

This idea has been so overblown that I believe it is
confusing investors into making bad investment decisions.  
They cannot see the forest through the trees.  There is a
financial term called Internal Rate of Return or IRR.  This
rate of return gives you the “net” rate of return over time.  
This is the rate of return
you earn after all fees and costs.  
This is the number you should use to pick investments, not
the fee amount.  Do you care if your fee is lower if your net
return is also lower?  I hope not.  Now that would not be
“smart.”  To be fair, I am not saying a high fee fund
guarantees a higher return.  The point I am making is that
fees are of little use in screening investments.  

If you have all your money in Vanguard or some other low
expense fund family, you have fallen for this ploy.  Vanguard
has some good funds.  But they don’t have all the good
funds by a long shot.  I have used some Vanguard funds in
my managed portfolios, but I don’t use them because their
fund fees are low.  I use them if their performance is good.  
Look beyond "the fee phenomenon"!  

Studies have shown that asset allocation is the largest
predictor of returns.  Asset allocation in combination with
your risk tolerance and tax situation should be your primary
concern and that is where we place most of our efforts and
expertise.  In closing, let me say it one more time:  Picking
your own low fee mutual funds does not guarantee you will
get a higher return.  As Mr. Clark pointed out in his study,
it doesn’t even put the odds more in your favor.

Sincerely,

Lynn C. Appelman, CFP® & ChFC®

June 18, 2009














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Lynn Appelman article debunking the low cost mutual fund myth