expense ratio costs included in "total return"?

[simple girl]

Hi all,

This may be a very basic question, but it's important.

I use M* when I evaluate mutual funds. I always look at the expense ratios and of course the returns. When reading a little bit about how M* reports the returns, I found this:

"The total returns account for management, administrative, and other costs automatically deducted from fund assets."

Does this mean the returns listed by M* already include the costs indicated by the expense ratio? I always thought the expense ratio was extra...and thus if 2 funds in the same category had nearly identical returns over the years, I would choose the one with the lower expense ratio. However, if the exp. ratio is already accounted for in the returns, then shouldn't one just look at the returns This is contrary to everything I have ever read, so I'm thinking I'm really misunderstanding what I quoted above. Can someone please help clarify? Please be kind and remember no question is a stupid question.

[LOL!]

mutual fund and ETF annual expense ratios are already accounted for in the total return.

Front-end loads are usually not included in the total return unless explicitly stated.

As for just looking at the returns, I don't think you can just look at the returns. Two other very important criteria need to be looked at as well:
1. Return after taxes.
2. Risk level.

A good example is comparing Dodge&Cox International (DODFX) to a typical international index fund. Since DODFX contains a healthy slug of emerging markets, you do not want to compare to an index fund that does not have a healthy slug of emergening markets.

[simple girl]

Quote:

Originally Posted by LOL! mutual fund and ETF annual expense ratios are already accounted for in the total return.

This does make me wonder, though - why DO we all talk about how important expense ratios are, if the bottom line (apart from the other factors - taxes, etc.) is that the M* total returns already account for them?

[target2019]

Quote:

Originally Posted by simple girl This does make me wonder, though - why DO we all talk about how important expense ratios are, if the bottom line (apart from the other factors - taxes, etc.) is that the M* total returns already account for them?

This article does a good job of explaining an index, and why some funds are better than others. Funds that have lower expenses let you keep more of the return.

[LOL!]

Back end loads are not included either unless explicitly stated.

[Koolau]

Quote:

Originally Posted by target2019 This article does a good job of explaining an index, and why some funds are better than others. Funds that have lower expenses let you keep more of the return.

Frightening to think some companies charge north of 1% for an S&P 500 index. More frightening is that someone would PAY north of 1% for it.

Having said that, just over a decade ago, I was naive enough to pay a load for a fund. Admittedly it was "proprietary", but I'm sure I could have found a fund which would mimic the fund for no load.

As long as I learn from mistakes, I guess it's OK.

[DblDoc]

Quote:

Originally Posted by Koolau Frightening to think some companies charge north of 1% for an S&P 500 index. More frightening is that someone would PAY north of 1% for it. Having said that, just over a decade ago, I was naive enough to pay a load for a fund. Admittedly it was "proprietary", but I'm sure I could have found a fund which would mimic the fund for no load. As long as I learn from mistakes, I guess it's OK.

Learned the same lessons myself. Some pay the higher ER fees because they have no choice - a 1% ER S&P 500 index fund may be the cheapest fund in their plan. Hopefully some of the change Obama promises will be to bring some fudiciary responsibility into creating retirement plans for employees.

DD

[DblDoc]

Quote:

Originally Posted by simple girl This does make me wonder, though - why DO we all talk about how important expense ratios are, if the bottom line (apart from the other factors - taxes, etc.) is that the M* total returns already account for them?

Because the expenses are the one thing we as investors have control over and compounded over time it adds up to a lot of money. Do not fall into the trap of evaluating funds based on M* "Total Returns". It is subject to bias based on when you choose to start and stop and frequently is comparing apples to oranges - particularly with managed funds. Another good reason to stick with index funds .

DD

[simple girl]

Quote:

Originally Posted by DblDoc Because the expenses are the one thing we as investors have control over and compounded over time it adds up to a lot of money. Do not fall into the trap of evaluating funds based on M* "Total Returns". It is subject to bias based on when you choose to start and stop and frequently is comparing apples to oranges - particularly with managed funds. Another good reason to stick with index funds . DD

When you say it is subject to bias do you mean my bias of what years I look at or that M* is biased in how they figure their total returns?

If it is my bias you are talking about, I agree that it is easy to say "Wow, look at the return this fund had this year, I gotta get in!" However, that's not what I am talking about. I look at the returns for all the years the fund has been in existence, and choose funds that have been around at least 5 years, preferrably 10. I look to see how many times they were above and below their categories for those 10 years. One of the books by Bogle (if I remember right) said you should look for funds that either match their category or outperform their category the majority of the time. So, if a fund falls below their category (by more than just a small amount) more than 3 or 4 of those 10 years, I stay away.

So, what if we had 2 hypothetical funds. Both have been above their category the majority of the time over 10 yrs. You look at 10 yr annualized total returns. Fund A's return is 10%. Fund B's return is 9%. Fund A has an expense ratio of 1.1. Fund B has an expense ratio of .6. They are both no-load. All else being equal, why would you choose Fund B?

BTW, I have ALWAYS been super concerned about expenses, keeping all my exp. ratios as far below 1% as possible. Now that I realize they are already figured into the total return, well...it's shaken me a little, and I really need to understand this. I appreciate everyone's help.

[target2019]

Quote:

Originally Posted by simple girl So, what if we had 2 hypothetical funds. Both have been above their category the majority of the time over 10 yrs. You look at 10 yr annualized total returns. Fund A's return is 10%. Fund B's return is 9%. Fund A has an expense ratio of 1.1. Fund B has an expense ratio of .6. They are both no-load. All else being equal, why would you choose Fund B?

What are the specific funds you refer to? Looking at two metrics for two hypothetical funds serves what purpose?

If these two funds are index funds, then the lower expense fund will have higher return.

You have to look at other measures of risk to see how closely the two funds track their index.

[haha]

Quote:

Originally Posted by simple girl So, what if we had 2 hypothetical funds. Both have been above their category the majority of the time over 10 yrs. You look at 10 yr annualized total returns. Fund A's return is 10%. Fund B's return is 9%. Fund A has an expense ratio of 1.1. Fund B has an expense ratio of .6. They are both no-load. All else being equal, why would you choose Fund B?

Mostly religion. It is an article of faith among certain mutual fund investors that no skill is ever involved. Beyond expenses, it's all luck. And luck can turn on you.

I have no interest in debating this point, but I think this attitude reflects prejudice more than evidence.

Ha

[ziggy29]

Quote:

Originally Posted by simple girl So, what if we had 2 hypothetical funds. Both have been above their category the majority of the time over 10 yrs. You look at 10 yr annualized total returns. Fund A's return is 10%. Fund B's return is 9%. Fund A has an expense ratio of 1.1. Fund B has an expense ratio of .6. They are both no-load. All else being equal, why would you choose Fund B?

Depends on your school of thought. If you believe that there is some aspect of "skill" in stock picking ability, you might pick Fund A. If you believe in the "efficient market hypothesis" -- the "random walk" theory where differences in performance are explainable only by luck that will eventually run out and that a monkey has a 50/50 chance of outperforming a professional stock picker -- you'd go for the lower cost alternative in just about all cases -- fund B since you believe there is no such thing as "stock picking skill." Or, at the very least, it's so difficult to identify *true* market-beating ability that you'd stick with indexing (and you aren't willing to risk underperforming the indexes).

And arguments between these two camps are often akin to debating politics or religion. They are utterly useless because both sides are often firmly entrenched in their beliefs and no one will ever be swayed by arguments from the other side no matter how cogent.

For what it's worth, my core portfolio is indexed but I do have a smattering of managed funds with good long-term track records and reasonable fees (below 1%).

[ziggy29]

M* total return is after annual recurring expenses and includes capital gains and dividends. It does not factor in the loads.

[simple girl]

Quote:

Originally Posted by LOL! Front-end loads are usually not included in the total return unless explicitly stated.

Are back-end loads included in the total return?

Quote:

Originally Posted by LOL! As for just looking at the returns, I don't think you can just look at the returns. Two other very important criteria need to be looked at as well: 1. Return after taxes. 2. Risk level. A good example is comparing Dodge&Cox International (DODFX) to a typical international index fund. Since DODFX contains a healthy slug of emerging markets, you do not want to compare to an index fund that does not have a healthy slug of emergening markets.

Excellent points. Why is it the more you know, the more you realize you don't know? Oh well, that's life!

Quote:

Originally Posted by ziggy29 M* total return is after annual recurring expenses and includes capital gains and dividends. It does not factor in the loads.

So, same question to you - does it include back-end loads? (No, not considering purchasing load funds, but my brother did, and I'm trying to learn more to help him. Actually we are learning a lot together by going through this process!)

[Alan]

Quote:

Originally Posted by simple girl Hi all, This may be a very basic question, but it's important....... ........Please be kind and remember no question is a stupid question.[/FONT]

Don't be embarrassed, you are asking basic questions that many of us don't know or can't remember the answers to, so we need to have the basics repeated every now and again.

[simple girl]

Quote:

Originally Posted by Alan Don't be embarrassed, you are asking basic questions that many of us don't know or can't remember the answers to, so we need to have the basics repeated every now and again.

Thanks Alan!

[LOL!]

Let me give another instance of comparing funds. My 401(k) plan has an intermediate term bond fund in it: Calvert Income CFICX. In the 401(k) we don't pay the front-end load. So a question might be, is is better to use CFICX in my 401(k) or to use the Vanguard Intermediate-term bond index fund VBIIX in an IRA for some of my bond allocation? Also you are making this decision in January 2007.

CFICX expense ratio is about 1.16% while VBIIX has about 0.2% expense ratio.

In 2003, CFICX had a Morningstar rank of 1 (better than all funds) in its category and in 2004-2006 it was ranked 3, 10, and 18. So it was always in the top 20% from 2003-2006. However in 2008, it lost 13% and the 10-year return is about 4.7%

VBIIX was ranked 28, 10, 54, 53 from 2003-2006. In 2008 it made 4.9% and the 10-year annualized return is about 5.75%.

So given the M* information in January 2007, which of these funds would you have picked? Go by performance and ratings? Or go by expense ratio? Or go by some other information?

[simple girl]

Quote:

Originally Posted by LOL! Let me give another instance of comparing funds. My 401(k) plan has an intermediate term bond fund in it: Calvert Income CFICX. In the 401(k) we don't pay the front-end load. So a question might be, is is better to use CFICX in my 401(k) or to use the Vanguard Intermediate-term bond index fund VBIIX in an IRA for some of my bond allocation? Also you are making this decision in January 2007. CFICX expense ratio is about 1.16% while VBIIX has about 0.2% expense ratio. In 2003, CFICX had a Morningstar rank of 1 (better than all funds) in its category and in 2004-2006 it was ranked 3, 10, and 18. So it was always in the top 20% from 2003-2006. However in 2008, it lost 13% and the 10-year return is about 4.7% VBIIX was ranked 28, 10, 54, 53 from 2003-2006. In 2008 it made 4.9% and the 10-year annualized return is about 5.75%. So given the M* information in January 2007, which of these funds would you have picked? Go by performance and ratings? Or go by expense ratio? Or go by some other information?

OK, this is like a fun little test. I'm sure I will not get an "A", but it's a good chance for me to learn some more....so....

I would want to see more years of history so I would pull the M* fund report which would show me data from 1998. Looking at 1998 thru 2006, CFICX was in the top quartile 7 of those 9 years. VBIIX was in the top quartile 5 of the 9 years (if you include top 1/2 of category, 6 of 9 yrs).

At first glance, seems like CFICX would be the way to go (given you don't have to pay a load in the 401K). Of course now with hindsight we see it did quite poorly compared to its category in 2008. Could we have predicted that by looking at other factors? Hmmmm....would the high expense ratio have predicted that it wouldn't do well in 2008 Hmmmmm...

Something I noticed is that when you look at the style box, CFICX is listed as medium quality, short duration. VBIIX is listed as high quality, long duration. So are we really comparing apples to apples here? M* has them both listed as Interm-Term bond funds...why? Why does the style box not agree with this? I'm sure I am missing something here and one of you all can enlighten me! If they aren't truly holding the same kinds of bonds, then how could you expect to compare them? I think I am starting to learn you can't just go by the M* category listing. You have to delve deeper. Gee, I thought I was doing pretty good until now!

P.S. I did just now read the analyst report and it says the manager for Calvert strayed from his strategy a bit, increasing the risk of the fund. This surprises me, given that he has been with the fund since 1997; it's not like a he is a new manager. Maybe the other new manager that came on in 2008 influenced him? I don't know, just conjecture on my part. However, this does also point out that there is a different risk with managed funds - the risk of human error. With an index fund it is obviously going to be more predictable, eh? No straying from the guidelines?

Oh, BTW, Calvert's 15 year average is 5.68, pretty close to VBIIX's 10 yr ave of 5.75%. Over the long haul, I wonder how much difference it all makes?

[youbet]

LOL,

The historic performance metrics you're using are an important factor, but you really need to also give consideration to the funds style and objectives. Is the fund going own the type of investments and manage them in a style you're seeking for the future? Then, use ER and historical performance to make a final decision.

[LOL!]

These two funds are intermediate term bond funds. My point is that one cannot actually use historic performance and it is a misleading factor.