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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 250 Schoolhouse Road, Bloomsburg, PA 17815 (570) 784-1716 or (800) 598-4998 Fax: (570) 784-8768 Securities Offered through Trustmont Financial Group, Inc. Member FINRA/SIPC and Registered Investment Advisory Services Offered through Trustmont Advisory Group, Inc. 200 Brush Run Road, Suite A, Greensburg PA 15601 (724) 468-5665 * Appelman Financial is not affiliated with either Trustmont Financial Group, Inc. or Trustmont Advisory Group, Inc. |
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