Fund Fees And Performance

A key advantage to exchange traded funds (ETFs) is their ultra-low expense ratios (on average) compared to the expense ratios of mutual funds. Although the expense ratio is only one factor to consider, studies show that over long periods of time, it can save or cost you vast sums of money.

A recent study done by MarketRiders digs down and gives us a look at how high fees hurt you over long time periods and the results should stun anyone trying to save for retirement.

MarketRiders CEO Mitch Tuchman created two portfolios: each started with $100,000, assumed a $4,000 annual contribution, an average expense ratio of 0.21% for the ETF portfolio and a 1.39% expense ratio for the mutual fund portfolio and an annual 7.5% return. The portfolios were composed of plain vanilla funds held in a non-taxable account.

What happened? Well, we’ll let the numbers do the talking:

If an investor opened each account at age 35, by age 76 his mutual fund portfolio would be worth $2.04 million while his ETF portfolio would be worth a considerably larger $3.15 million.

Whoa.

Granted, the situation is highly theoretical since it is unrealistic to assume that both portfolios would perform identically. But the example shows the strength of compounding interest, even with small percentage differences, over a long period of time.

Sure, the generally lower expense level of ETFs can have a positive outcome when looking at the long-term effects of compounding. However, there are a few other thoughts to consider.

If you are simply buying and holding, as opposed to tracking trends, these alleged savings can and will be eaten up next time a bear market strikes such as we’ve seen in 2000 and 2008. To my way of thinking, it’s more important to focus on an investment strategy, such as trend tracking, that prevents participation in severe market drops, which can save your portfolio from a serious decline as opposed to saving a few dollars in annual fees.

I have found that only looking at expense ratios to make a mutual fund/ETF selection does not tell the whole story. I remember the rebound from the bear market in 2003 during which one of our mutual fund holdings rallied some 60% in 90 days.

Do you think it mattered to me that they had one of the highest expense ratios in the industry? Of course not, because it’s not a matter of what something costs but what it will do for you. That is one of the most often overlooked factors in the race and sometimes misplaced focus of finding nothing but the lowest price.

That’s why in my selection process of ETFs/mutual funds for trend tracking, momentum ranks way above expense ratios, because that’s the ingredient which will provide us with potential capital gains. If low costs happen to be part of my selection, then I will take that as a bonus but not as a criterion.

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