Dale, Mutual fund management fee charges are an element in considering in investing. One reason is fee charges are required to be disclosed by regulations. Since the fee charges are disclosed they can be compared. If two mutual funds of the same type have similar performance, an investor should pick the fund with lower fees.
When looking at mutual funds or exchange traded funds (ETFs) for my clients, I focus on performance net of charges. Performance counts. One individual told me, the mutual funds with the most expensive fees are never in the top 20% of performance. I would rarely buy a fund that wasn't in the top 20% of its respective mutual fund category. The exception is when I believe the market is making a major trend change. I did this in December 2008. I bought mutual funds that were leveraged index funds. These funds where designed to return double the rate of their respective benchmark index, like the S&P 500. I was 3 months early. All my clients liked their returns through 2011. I am no longer employing this strategy for my clients.
Hedge funds charge as much as 2% management fees plus 20% of the profits or more. If a hedge fund has annual gross profit before charges of 11.4%, the average gross return before fees according to one source on Wikipedia, the net of fees return to the investor would be 7.12%. The total fee charge would be 4.28% for the year.
I do not know of any proof of a relationship between fees and performance. Passive funds, which mirror indexes’, would have better performance with lower fees. Vanguard funds do tend to have lower fees. They don’t always have the best performance.
My focus is on performance after fee charges. I have never seen Vanguard publish an asset allocation model recommending how much to invest in which markets. Asset allocation is over 90% of the rate of return of an investor’s portfolio.
I provide my current recommendations for growth investments at no charge to anyone who wishes to use the recommendations, at their own risk, at http://davesfavs.com/
I recommend you find a professional you trust and pay them what you believe is fair. Most professionals don’t work for free. You want to employ the person helping you grow and preserve your wealth. It makes you the Boss. Your financial security is, after your health, one of the most important parts of your life.
Good luck, Dave
A higher-than average fee on a mutual fund or ETF is a red flag but not always a deal killer. The question you should ask yourself is "What does this manager do that is fundamentally different than the cheaper competition?"
If the manager is a large-cap growth manager that closely tracks the S&P 500 (we call those "closet indexers"), there is absolutely no reason to pay a premium. In these cases, cost really does matter and you'd likely be better off with a cheap index fund.
But if the manager runs a concentrated portfolio, invests in harder-to-access foreign markets, or engages in an investment style that is hard to copy, a fee in the 1-2% range might be completely reasonable.
Just ask yourself the simple question of "What am I getting for my money."
On a side note, it is not just perfomance that matters in these cases (though performance certainly does matter; no one wants to pay a manager to lose money). Diversification matters too. If a manager's style is relatively uncorrelated to the rest of your portfolio, his fee could certainly be worth paying.
Hi Dale, That seems to be a very important questions these days. The reason it is "important", in my opinion, is because of Marketing. Two things to remember: 1) You get what you pay for. 2) People do what they are compensated to do. The primary reason for the emphasis on "low fees" is that "low fee fund providers" make money when people choose to buy their fund over another. These low fee funds do not pay commissions to the licenses broker(who is expected to advise you) therefore you are not getting guidance because you aren't paying for it. This is fine for highly educated, experienced investors. There is no need in paying for what you do not need. On the other hand, maybe you do. I am in favor of using low cost investment and hiring an advisor that works for you on a transparent, tangible-fee basis. How much is too much? You decide based on what your needs are. Do not be fooled into thinking low cost is better just because the people that sell "low fee" investment tell you they are better. Concentrate on "good value versus bad value" not "cheap versus expensive". Using a Fee-based advisor allows you to know and control exactly what you are paying for based on what your needs are. If your situation requires a lot resources, you will pay more(I charge 2% annually, but use stocks and low expense ETF's and do not charge commissions). If you require less, you should pay less(I do not charge a fee to simply hold assets). To summarize, there are threedesirable components of asset management: Performance, Service, and Low Cost. You can only pick two and have them consistantly delivered. "Low Fees" are not everything.
I believe that often times you get what you pay for. I believe fees have been shrinking for years. On the other hand, the appropriate question seems to be what is the fee in relation to the performance of the accounts? A Jefferson National survey found that 75.5% of financial advisors believe active portfolio managers can outperfrm an index over the longer term. I find it interesting that few, very few financial advisors actually publish the portfolio performance their clients achieve. I actually do. You can find my performance on my website, www.adamsfinancialconcepts.com.
Actual studies show something very different from what financial advisors believe. Charles Ellis in his book, "Winning the Loser's Game" states that fewer than 20% of money managers actually beat the market over the longer term. Burton Malkiel, "A Random Walk Down Wall Street" studied mutual fund managers and found that same result. Even worse, in my opinion is an annual study done by Dalbar examining the average mutual fund investor's performance compared to the index. Using the study for the 20 years from January 1, 1988 through December 31, 2007 the average equity mutual fund investor achieved 4.48% annually compared to the S&P500 return of 11.48%. In dollar terms, that mean the average investor if they began with $100,000 would have achieved about $240,000 at the end of 20 years. However, that same investment in the S&P500 would have been $932,000!! The Dalbar study which includes the Great Recession of 2008-9 shows the individual investor achieving half the return of the S&P500. Past Performance is no guarantee of future returns,of course. But for 75.5% of financial advisors who believe active managers outperform, it seems a little pie in the sky.
Josh Brown who has written a book called "Backstage Wall Street" says "Most of the brokers I know and have met over the years are phenomenal, world-class salespeople...But a great many of these securities-selling savants don't attain the knowledge necessary to actually accomplish anything for their clients. As I have come to learn over the years, selling one's expertise is much easier than actually developing an expertise, especially as it pertains to investing."
I believe that is a reason so very few financial advisors post actual results on their websites and why the large wirehouses really do not want them to post results. I believe that is also the reason that fees seem to be falling as investors evaluate performance. All of this, is, of course, my opinion.
A few thoughts on this topic:
First, in most cases you should be seeking out passive funds, whether they are cap-weighted traditional index products or fundamentally-weighted "smart" indexes - like dividend or earnings quality, etc. These come in the form of ETFs so the internal cost should be under 70 basis points for the most part and under 50 basis points in many cases.
For areas in which you seek more active management, you should keep the folloiwng in mind: There is no metric that's been found to consistently predict good performance for any mutual fund type more than low fees. Low costs are the first determinant you should consider, above all other factors at first. Once you've narrowed the category down thusly, then you can do yiour homework on the managers, the portfolio etc.
Russ Kinnell of Morningstar documents this phenomenon here:
"How Expense Ratios Performed If there's anything in the whole world of mutual funds that you can take to the bank, it's that expense ratios help you make a better decision. In every single time period and data point tested, low-cost funds beat high-cost funds. To see the results, click here.
Expense ratios are strong predictors of performance. In every asset class over every time period, the cheapest quintile produced higher total returns than the most expensive quintile.
For example, the cheapest quintile from 2005 in domestic equity returned an annualized 3.35% versus 2.02% for the most expensive quintile over the ensuing five years. The gap was similar in other categories such as taxable bond, where cheap funds returned 5.11% versus 3.82% for pricey funds. That same relationship held up dependably in the other time periods we measured. For 2008, the cheapest quintile of balanced funds lost 0.04% over the next two years, while the most expensive shed 1.13%."
Dale – Fund management expenses depend on several factors: stocks versus bonds, domestic versus international, active versus passive. Stock funds are generally more expensive than bond funds, international funds more expensive than domestic, and the majority of passive or index funds significantly below actively managed (through stock or bond picking and market timing). Over several years, index funds typically outperform actively managed funds. You also need to factor in costs other than fund management such as the funds trading costs and tax bill they create for you. Index or passively managed funds hold a large basket of stocks which means they do not trade frequently. Actively managed funds pick individual stocks and hold more concentrated portfolios. They typically trade more and this detracts from the funds returns. When they trade they can also generate taxable gains – short term tax at your marginal rate and long-term taxed at 15% for now. In contrast, the gains tend to build in passively managed funds and not distributed to owners so they are much more tax efficient. In my opinion, the biggest decision you need to make is whether to use passive funds (e.g., most of Vanguards funds, iShares and other ETF’s, or Dimensional Fund Advisors). As far as the best approach, this is what Warren Buffett wrote in a Berkshire Hathaway annual report: “Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees.” The next decision is the proportions of stocks versus bonds, and finally the mix of US and international stocks. A deeper discussion is on my website (Knowledge is Power page) here: http://www.granitehillcapital.com/pdf/Begin%20Your%20Journey%20With%20Stock-Bond%20Decisions.pdf I’m sure other advisors on this platform will add more specific and valuable information on your question. Hope this helps and good luck.
There really is no correct answer to this question, but here are some thoughts. First, "FEES MATTER!" Most fund managers don't beat their benchmark, which is usually a function of the hurdle of management fees, operating fees and commissions imbedded in their fund. Luckily for you, the mutual fund industry has been going through an unprecedented period of fee compression, fueled in no small part by the introduction of ETFs and low cost index funds.
The question really is, do you need to pay for "Active" management, or can you and/or your advisor do a good enough job without it? Studies show that the vast majority of your returns come from asset allocation and not securities selection, therefore, you need to think long and hard about paying 2-5x the management fees of Passive funds in order to buy Active management. They better be worth it.
I think you should start with the premise that Passive, low-cost funds are your default solution, then analyze the Active management funds in the same asset class to see if you believe they are worth the extra fee. If you are investing in a taxable account, also review the turnover ratios, as high turnover equals more potential tax liability. Pay special attention to the "Alpha." This is a measurement of the manager influence on performance vs. the benchmark. Obviously, negative Alpha, is not a good thing!
FYI, unless you have a strong finance background and the time to commit to your portfolio, having a good advisor really helps!
Dale, To start, the average cost of an equity (stock-investing) mutual fund has been researched to be about 1.42% annually, so that should be used as an absolutely worst case scenario. As others have mentioned there is a very clear relationship between fund fees and performance. If Morningstar, whose business is dependent upon their star rating system, can admit that fund fees are the best predictor of future performance, you can believe it is true.
Morningstar's Russell Kinnel said: “In every single time period and data point tested, low-cost funds beat high-cost funds."
You should also recognize that disclosed fund expenses are only part of the total cost of owning actively managed mutual funds. A study published in 2007 (here: http://www.frontadv.com/files/1267653327_The%20Role%20of%20Trading%20Costs%20in%20MFs.pdf) found that internal trading costs of actively managed funds range from an additional 1.20% to 1.44% on top of the average 1.42% expense ratio.
This means that even before taxes, the cost of actively managed funds is approaching 3%. Lipper's annual tax study typically finds that the cost of taxes on distributions from mutual funds can run close to an additional 1% (it was 0.98% in the 2010 study).
John Bogle was right: in investing, you get what you don't pay for. It is not difficult for investors (and their advisors) to build cost effective, tax efficient portfolios with ETFs starting around 0.10%-0.20%.