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expense ratio vs return
Old 03-16-2018, 08:44 PM   #1
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expense ratio vs return

I have read where people say to get the lowest e/r fund and stick with that. Am I missing something. I have read where lower e/r funds out perform higher e/r funds but is that if they have the same ytd returns. Let say just for grins that we have 2 funds 1 with a e/r of .06 and a annual return of 10% would that out perform a fund with a e/r of 1% and a return of 12%. Reason I am asking is I am invested in a vanguard fund with a .06 e/r and a 3% ytd return so far this year and another fund with a e/r of .8 and a ytd return so far of 10%. Just need it dumbed down for me as I tried to Google the answer but it was above my head and I think they were comparing funds that performed the same. And yes I know past performance is not a indicator of future performance I just want to make sure I understand this correctly.
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Old 03-16-2018, 09:07 PM   #2
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Over long periods of time(10-15 years) expense ratio is the best determiner of success for two mostly identical funds. Two intermediate bond funds with similar risk profiles will separate based on expenses over long periods of time. The same is true for stock funds that follow the same risk profiles. It is much more complicated than my explanation, but books have been written on the subject- The little Book of Common Sense Investing is a good one.
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Old 03-16-2018, 09:29 PM   #3
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Originally Posted by hopefullyoneday View Post
I have read where people say to get the lowest e/r fund and stick with that. Am I missing something. I have read where lower e/r funds out perform higher e/r funds but is that if they have the same ytd returns. Let say just for grins that we have 2 funds 1 with a e/r of .06 and a annual return of 10% would that out perform a fund with a e/r of 1% and a return of 12%.
No, because the expense charges are already figured into the annual return. The fund with a return of 12% has already had the ER of 1% factored into the calculation. So has the fund with ER of .06 and annual return of 10%. The fund returning 12% is winning.

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Reason I am asking is I am invested in a vanguard fund with a .06 e/r and a 3% ytd return so far this year and another fund with a e/r of .8 and a ytd return so far of 10%.
Yeah, the fund with the ER of 0.8 and annual return of 10% is blowing the doors of the Vanguard fund with the 3% return.
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Old 03-16-2018, 09:39 PM   #4
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WADR, it is foolish to assesses fund performance based on YTD returns in March.

IMO, only 3, 5 or 10 year periods are worth looking at.

Q is right that the published returns are net of expenses. Over long periods of time, low ER funds tend to outperform high ER funds that are in the same space.
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Old 03-16-2018, 09:44 PM   #5
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No, because the expense charges are already figured into the annual return. The fund with a return of 12% has already had the ER of 1% factored into the calculation. So has the fund with ER of .06 and annual return of 10%. The fund returning 12% is winning.



Yeah, the fund with the ER of 0.8 and annual return of 10% is blowing the doors of the Vanguard fund with the 3% return.
Thank you for the simple answer, I get confused when I read info that is not comparable.
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Old 03-16-2018, 09:49 PM   #6
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WADR, it is foolish to assesses fund performance based on YTD returns in March.

IMO, only 3, 5 or 10 year periods are worth looking at.

Q is right that the published returns are net of expenses. Over long periods of time, low ER funds tend to outperform high ER funds that are in the same space.
I was just using the ytd as a quick example. For instance last year ytd for the vanguard was 12.46 and a 10 yr of 9.92 and the other acct last year was 31.99 and a 10 yr of 11.11

When I pick a fund I look for the highest 10 year return then if there is a tied I look at the lowest e/r.
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Old 03-16-2018, 11:36 PM   #7
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So, help a bud out.

I have about 15% of my portfolio in a Growth fund that made 37.85% last year, and 18.75% life of fund (they changed names a few years ago. It looks like the expense ratio was 0.38%. Should I move the rest of my money into this fund?
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Old 03-17-2018, 05:31 AM   #8
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There's a reason they say that past performance is not an indicator of future results. Don't chase returns.

IMO, you should figure out your asset allocation first. How much do you want in stocks vs. bonds, domestic vs. international, large vs. mid vs small, sectors, etc. Then pick funds that will meet those goals. Performance and expenses are a big part of that selection, but beware performance after a strong market. A high risk taker may have done much better than the rest of the field in the recent bull market, but if they keep that style in a bear market they are likely to do much worse. That's why I say don't chase returns.

An easy way to meet my AA goals is to use the VG 3: Total Bonds, Total Market, and Total International. With those, I don't have to worry about finding balance in cap size or sectors, and they have the advantage of having about the lowest ERs you can find for their type of investment. They also have beaten many of the other options over the years. I still don't get why, because it doesn't seem that hard for me for an expert to start with an index model, eliminate what they think will be the worst 25% of holdings, and overweight what they think will be the best. Or even just spread that 25% out over the other 75%. But many seem to get it wrong, or can't overcome the costs of doing the research to beat the index.
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Old 03-17-2018, 05:33 AM   #9
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You need to consider risk. If both funds don't have the same risk, then you are comparing apples to oranges.
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Old 03-17-2018, 05:41 AM   #10
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You need to consider risk. If both funds don't have the same risk, then you are comparing apples to oranges.
Exactly!!
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Old 03-17-2018, 07:07 AM   #11
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So, help a bud out.

I have about 15% of my portfolio in a Growth fund that made 37.85% last year, and 18.75% life of fund (they changed names a few years ago. It looks like the expense ratio was 0.38%. Should I move the rest of my money into this fund?
Short answer is no, because you don't want all of your money in one investment.

Could you put more in that fund? Maybe. But it depends on your age, how long until retirement, your risk tolerance, etc.
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Old 03-17-2018, 07:07 AM   #12
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If two funds both invest in the S&P 500, buy the one with the lower expense ratio. If the two funds invest with a more proprietary strategy, than take the better long term performer.
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Old 03-17-2018, 09:01 AM   #13
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Whew! Thread drifting around a bit.

Re fund expenses, Morningstar has found that fund expenses are the best predictor of future fund performance. http://corporate1.morningstar.com/Re...ts/752589/file I would venture to say that expenses are the only known predictor, since no one has come forward with anything else that is statistically valid.

Re manager performance, S&P comes out every six months with their "Manager Persistence" report card. Invariably it shows that fund results are random and uncorrelated with past performance. https://us.spindices.com/documents/s...-june-2017.pdf Over 10 years this means that only a tiny percentage of funds beat their benchmarks and that it is not possible to identify the winners in advance. I am 99.99% certain that there is no statistical data that contradicts this, as if there were the active management advocates would be beating us over the head with it.

There are, in fact, multiple Nobel prize winners who will tell you that performances regresses to the mean and, hence, avoiding recent hot performers will actually turn out to be a wise strategy. Daniel Kahneman, in Thinking Fast And Slow, argues this quite strongly. Eugene Fama makes the same argument.

So ... buy broadly invested funds with the lowest expense ratios regardless of past performance, sit back, and enjoy the ride. Chasing hot managers is hazardous to your wealth.
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Old 03-17-2018, 09:16 AM   #14
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Expenses are not just high management fees, they also are trading costs for funds with high portfolio churn, and taxes on capital gains.

Here's a detailed view of the impact of fund expenses and taxes (from turnover) on returns and how much additional return an active fund needs to offset the higher expenses and taxes. https://www.researchaffiliates.com/d...Big-Enough.pdf
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Old 03-17-2018, 09:31 AM   #15
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Expenses are not just high management fees, they also are trading costs for funds with high portfolio churn, and taxes on capital gains.

Here's a detailed view of the impact of fund expenses and taxes (from turnover) on returns and how much additional return an active fund needs to offset the higher expenses and taxes. https://www.researchaffiliates.com/d...Big-Enough.pdf
Absolutely true! And the result is that few actively managed funds outperform and, again, the ones that will outperform cannot be predicted in advance.


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Old 03-17-2018, 10:58 AM   #16
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Absolutely true! And the result is that few actively managed funds outperform and, again, the ones that will outperform cannot be predicted in advance.
The performance of the market cannot be predicted in advance.

The return of an index fund will always be the average return of the market. There is no chance of outperforming the market.

An active fund does not need to outperform the index every year to outperform the index over 10 years. Depending on the margin, an active fund could win only a few years out of ten and still outperform the market over ten years.
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Old 03-17-2018, 11:52 AM   #17
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The performance of the market cannot be predicted in advance.
True. This is why stock picking fails in aggregate. It attempts to predict a future that is random.

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The return of an index fund will always be the average return of the market. There is no chance of outperforming the market.
Actually, the index fund will underperform its benchmark by the amount of its costs, including trading costs (Possibly slightly offset by fees for lending securities or other ancillary activities). The average stock picker fund will also underperform by the amount of its costs, which are much higher. That is why index funds on average outperform stock pickers. William Sharpe explained this to us in his 1991 paper "The Arithmetic of Active Management." Nothing has changed this arithmetic. Fama and French provided a statistical analysis that supports Sharpe in their 2010 paper "Luck versus Skill in the Cross-Section of Mutual Fund Returns."

(Note there is something subtle but important here. An index fund must be compared to an appropriate benchmark. For a Russell 3000 total market fund, the comparison is indeed "the market." For an S&P 500 fund, though, the comparison is to a US large cap benchmark like the S&P 500. There is an increasingly-popular scam where active managers compare themselves to inappropriate benchmarks, like a small cap fund comparing itself to the Dow or to the S&P. Caveat emptor.)

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An active fund does not need to outperform the index every year to outperform the index over 10 years. Depending on the margin, an active fund could win only a few years out of ten and still outperform the market over ten years.
And ... right for the third time. Every six months the S&P SPIVA report card shows that a small fraction of active funds outperform for various periods of time. The longer the time period, the smaller the number of outperformers. IIRC the 10-year outperformers are about 5% +/- 2% of the total number of funds, depending on which SPIVA report you are look at. Said another way, a fund that is randomly selected at the beginning of a ten year period will have about one chance in twenty of outperforming over the period.

The last, and probably most important consideration to follow the above true statements is this: It is not possible to identify outperforming funds ahead of time. This is consistent with the theory that outperformance is primarily due to luck and not to skill, which Fama and French deal with in the above-mentioned paper.

Larry Swedroe, a writer that many here respect, also explains: Research on Luck versus Skill in Mutual Fund Performance Highlights Active Management's Shortcomings It's worth a read. His last paragraph is:
"The choice is yours. You could try to beat overwhelming odds and attempt to find one of the few active mutual funds that will deliver future alpha. Or you could accept market returns by investing passively in the factors to which you desire exposure. The academic research shows that investing in passively managed funds is playing the winnerís game."
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Old 03-17-2018, 01:19 PM   #18
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True. This is why stock picking fails in aggregate. It attempts to predict a future that is random.
ALL investing attempts to predict a future that is random.

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And ... right for the third time. Every six months the S&P SPIVA report card shows that a small fraction of active funds outperform for various periods of time. The longer the time period, the smaller the number of outperformers. IIRC the 10-year outperformers are about 5% +/- 2% of the total number of funds, depending on which SPIVA report you are look at. Said another way, a fund that is randomly selected at the beginning of a ten year period will have about one chance in twenty of outperforming over the period.
Somewhat of a strawman argument. I would certainly hope no one "randomly" picks a stock mutual fund. Go with one with a lower expense ratio. Go with a no load fund. Go with one with a good track record. Examine the underlying portfolio. Look at the volatility. Examine the tax consequences. Etc.

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The last, and probably most important consideration to follow the above true statements is this: It is not possible to identify outperforming funds ahead of time. This is consistent with the theory that outperformance is primarily due to luck and not to skill, which Fama and French deal with in the above-mentioned paper.

Larry Swedroe, a writer that many here respect, also explains: Research on Luck versus Skill in Mutual Fund Performance Highlights Active Management's Shortcomings It's worth a read. His last paragraph is:
"The choice is yours. You could try to beat overwhelming odds and attempt to find one of the few active mutual funds that will deliver future alpha. Or you could accept market returns by investing passively in the factors to which you desire exposure. The academic research shows that investing in passively managed funds is playing the winnerís game."
Makes for a nice summary statement, but I don't see how accepting the average return is "winning". I wonder if the authors actually tracked some well known fund managers or merely relied on the old story about Peter Lynch and the Magellen fund or Warren Buffet's bet with the hedge fund managers.
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Old 03-17-2018, 01:21 PM   #19
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the last, and probably most important consideration to follow the above true statements is this: It is not possible to identify outperforming funds ahead of time.
bingo!
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Old 03-17-2018, 01:40 PM   #20
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... Somewhat of a strawman argument. I would certainly hope no one "randomly" picks a stock mutual fund. Go with one with a lower expense ratio. Go with a no load fund. Go with one with a good track record. Examine the underlying portfolio. Look at the volatility. Examine the tax consequences. Etc. ...
You're only six minutes from understanding this: https://famafrench.dimensional.com/v...-managers.aspx

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... Makes for a nice summary statement, but I don't see how accepting the average return is "winning". ..
It's in the eye of the beholder I guess. A passive strategy beats close to 95% of stock-pickers over 10 years and probably beats 99% of individual investors, who make many stupider mistakes than the stock pickers do. I consider a strategy that yields that result to be "winning." You might not.

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... I wonder if the authors actually tracked some well known fund managers or merely relied on the old story about Peter Lynch and the Magellen fund or Warren Buffet's bet with the hedge fund managers.
Well, if you wouldn't have to wonder if you'd read the linked articles and papers. If you'd rather continue to be ignorant there is not much I can do about that.
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