Cost of Investing Part II - Additional considerations when comparing fees

Cost of Investing Part II - Additional considerations when comparing fees

August 10, 2021
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In my blog, “Fees – part I, Mutual Fund Gross Expense Ratio” I illustrated the cost and performance difference between Green Index Fund and Blue Growth Fund.   Here, I want to expand on why these costs may differ.

 

When investing there are three basic types of mutual funds: index, growth and value.

 

  • Index funds are designed to track the components of a financial market index such as the S&P 500. The S&P 500 is very similar to the fortune 500 list.

 

  • Growth funds invest in stocks of companies, within sectors of the economy, that are expected to grow in the next 1 to 5 years.

 

  • Value funds typically invest in stocks of companies that make products and services we consume regularly.

 

Contrasting a value to a growth fund, “think things we use” vs. “things we want.” As an example, Colgate Palmolive vs. Apple.  Colgate Palmolive produces products we consume and purchase regularly, regardless of how confident we feel about our income.  Apple products may be more of a “want” vs. a “need” as their products are more expensive and do not need to be replaced as frequently.

 

Index funds are unmanaged and invest to mirror a financial market index. As an example, if the index fund was mirroring the S&P 500 and $500 came into the fund, the fund managers would invest $1 into each stock.  A company is removed from the index, and therefore the fund, when it falls to number 501 in size.   Companies do not fall out of the index often; it is more of buy-and-hold strategy.  Each trade has a ticket-charge and index funds do not have a lot of trading, generally resulting in lower fees.  


Fund managers of growth and value funds choose the stocks based on economic trends and their growth forecast. If the fund managers feel there is a risk with a given company, they may sell that stock and replace it with a similar investment that has a better economic forecast.   Due to the managers actively buying and selling stocks, they generally have higher ticket charges compared to an index fund.  Fund managers have a vested interest in the performance and are often required to invest their own money in the fund they manage.  When you make money, they make money.

Another example of why a fund expense could be high is due to the tax filings the fund incur.   I know of an oil fund that has an expense ratio of 2.39%, which seems very high, until you learn that they file a K1 in each state.   If the fund didn’t file this, the investor would have to do this on their own!   

 

Fund share classes have differing costs.   C Shares are the most expensive, designed for an investor with a short timeline of less than 3 ½ years, they are not very common.    A Shares offer the lowest operating costs for the retail investor but may include a front-end sales charge.  I Shares offered in employer sponsored retirement plans offer the lowest expense ratio.


Costs vary from fund to fund.  The frequency of trading within in the investment is often a leading explanation of higher costs.   While investment costs can’t be avoided, it’s important for you to be comfortable with and understand what you are paying.   If you have any questions about investment costs, or if I may help you with your financial needs, please do not hesitate to contact me.

 

 

Disclosures: Investing involves risk, including loss of principal. Content in this material is for general information, education and is not intended to provide specific advice or recommendations for any individual.   All indices are unmanaged and many not be invested into directly.  The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.  No strategy assures success or protects against loss.   1-05121293