Cost of Investing – Part I Gross Expense Ratio
Mutual Fund Gross Expense Ratio
Ahhh… The “fee discussion.” Every investment has a cost to it, does the investor asking investment costs have a foundation to know what is an acceptable or unacceptable fee? Do they have a foundation for comparison? Are they being taught how to understand the various expense, or are simply told a percentage? As a financial professional, educating investors to understand costs associated with investing, so they can make an informed decision, is one of my favorite discussions to have.
While momentum over the last decade has been to reduce expenses for the investor; to communicate this benefit, the industry has provided more disclosures and multi-page documents written in ”financial-ese” to inform investors of the costs associated with the investments. While well intended, my concern is they are left feeling overwhelmed and confused.
At face value, it is easy to compare the fund’s Gross Expense Ratio This fee is reflected as an annual percentage, which counts as the total percentage of a fund’s assets devoted operating the fund. Without explanation, one would assume the lower the percentage, the better fund.
Let’s compare the Gross Expense Ratio two mutual funds, nicknamed “Green Index Fund” and “Blue Growth Fund”. The Green Fund family has a reputation of being low cost, which is openly promoted on their website. The Blue Fund family offers numerous mutual funds, each with their own investment objective.
- Green Index Fund’s Gross Expense Ratios (cost) is 0.04%. This means $4 per $10,000 invested annually.
- Blue Growth Fund’s Gross Expense Ratio (cost) is 0.65%. This means $65 per $10,000 invested annually.
Blue Growth Fund has a substantially higher expense ratio than Green Index. Cost conscious investors may not consider looking further into this investment due to this difference. If the cost is all that matters, then the conversation should end here. If performance matters, then the comparison deserves a deeper look.
When an investment’s performance is listed on a fund’s website or document, it is net of expenses. Expenses are deducted, and the return listed is true to investment performance. I have listed the returns of both funds side-by-side and calculated the annual return on an initial investment of $10,000 over the last 22 years. Why 22 years? Because it covers 3 market downturns: the tech bubble (2000-2002) the housing bubble (2008) and Covid-19 (2020).
| Year | Green Index Fund Calendar year return | Annual investment growth in dollars | Blue Growth Fund calendar year returns | Annual investment growth in dollars |
|
|
| $10,000 |
| $10,000 |
1 | 1999 | 21.17% | $12,117 | 25.03 | $12,503 |
2 | 2000 | -8.94% | $11,034 | -6.8% | $11,653 |
3 | 2001 | -11.93 | $9,718 | -12.59% | $10,186 |
4 | 2002 | -22.03 | $7,577 | -9.63 | $9,205 |
5 | 2003 | 28.66 | $9,749 | 27.95 | $11,778 |
6 | 2004 | 10.86 | $10,808 | 15.07 | $13,553 |
7 | 2005 | 4.91 | $11,339 | 16.23 | $15,753 |
8 | 2006 | 15.78 | $13,127 | 11.54 | $17,571 |
9 | 2007 | 5.47 | $13,845 | 19.78 | $21,047 |
10 | 2008 | -36.95 | $8,729 | -37.16 | $13,226 |
11 | 2009 | 26.63 | $11,054 | 29.43 | $17,118 |
12 | 2010 | 15.05 | $12,718 | 17.09 | $20,044 |
13 | 2011 | 2.09 | $12,984 | -0.02 | $20,040 |
14 | 2012 | 15.98 | $15,059 | 16.4 | $23,327 |
15 | 2013 | 32.35 | $19,930 | 34.3 | $31,328 |
16 | 2014 | 13.65 | $22,651 | 9.68 | $34,360 |
17 | 2015 | 1.37 | $22,961 | 6.55 | $36,611 |
18 | 2016 | 11.93 | $25,700 | 3.48 | $37,885 |
19 | 2017 | 21.79 | $31,300 | 32.34 | $50,137 |
20 | 2018 | -4.42 | $29,917 | -2.07 | $49,099 |
21 | 2019 | 31.46 | $39,329 | 30.17 | $63,912 |
22 | 2020 | 18.39 | $46,562 | 32.68 | $84,798 |
This is a hypothetical example for illustrative purposes only.
The more expensive Blue Growth Fund earned $38,236, or almost 55% more for the investor. Did the lower cost (0.04%) matter? Another way to ask this question is, which fund cost the investor more based their account balance? As the investor, would you rather have an account balance of $46,000 or $84,000? My experience of as a financial professional is investors want to see their investment grow and performance outweighs expenses.
In my follow-up blog, “Fees Part II,” I expand on additional fund expenses to compare. Please contact me if you wish to discuss this piece further or if I may assist with your financial goals.
Disclosures: Investing involves risk, including loss of principal. Content in this material is for general information and is not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and many not be invested into directly. No strategy assures success or protects against loss. 1-05121290