Study Sheds Light on Funds' Hidden Trading Costs

[bUU]

http://www.nytimes.com/aponline/2013/03/14/business/ap-us-of-mutual-interest-trading-costs.html

None of this is particularly new but it does serve as a good reminder of another down-side of active trading. It prompted me to do a quick comparison just to reinforce the point in my own head:

Fidelity® Magellan® Fund - a large-cap growth fund, that seeks capital appreciation by investing in common stocks.
Symbol: FMAGX - Turnover = 87%

Fidelity's Spartan® 500 Index Fund - a large-cap index fund, that tracks the index that Fidelity® Magellan® Fund is often compared against.
Symbol: FUSEX - Turnover = 3%

Now compare their relative returns over 1 month, 3 months, 6 months, 1 year, 5 years, 10 years. Fidelity's Spartan® 500 Index Fund wins every time. So even with a relatively low-cost actively-managed fund, like Fidelity® Magellan® Fund (ER 0.55%, versus 0.10% for FUSEX), the aggregate impact of expenses, trading costs associated with turnover, and the simple fact that monkeys are more often than not better stock pickers than even the best Wall Street fund managers, makes my decision pretty clear: We're going to steer away from actively-managed funds, and climb on board the total market through investing in total market index funds.

 

[Texas Proud]

Yep, cost does matter.... in your example the cost difference is more than 5X...


It also points out that once a fund get very large, they can not do a whole lot of things different than the market...

IOW, a small fund can overweight in some area that will make a visible difference in it's total return, but a large fund does not have this ability...

 

[rbmrtn]

FMAGX suffered from its own success. I owned it the 80's under Peter Lynch and it was fantastic. I sold it around '95, Lynch had left, it got to big to manage and became a proxy for the S&P, an index fund with high cost.

 

[bUU]

Yep, cost does matter.... in your example the cost difference is more than 5X...

The article seems to be saying that (although we don't know by precisely how much) the cost difference between those two funds is much more than 5X. Someone just posted this on Bogleheads:

Also refer to this detailed study on trading costs from 2009: R.W. Kopcke, F.M. Vitagliano and Z.S. Karamcheva, Fees and Trading Costs of Equity Mutual Funds in 401(k) Plans and Potential Savings from ETFs and Commingled Trusts, Center for Retirement Research Paper WP 2009-27 (2009), 32pp.

They estimated the following relationship between stock turnover and annual trading costs:
7% turnover --> 0.11% cost
36% turnover --> 0.39% cost
45% turnover --> 0.66% cost
50% turnover --> 1.15% cost
79% turnover --> 1.99% cost

So if I understand that research correctly, the cost difference between FUSEX and FMAGX is closer to 16X (1.99 + 0.55 / 0.06 + 0.10).

 

[jerome len]

Overall, I'm a believer in index funds. Yes, some funds get hot but if you chase hot funds, you buy them just as they get cold.

We are with Fidelity and they sell managed funds hard. We try to buy low cost managed funds with an above average 5 year record......then, the majority of the time they go cold.

We insist on a decent selection of index funds along with Fidelity managed funds. Our employees have a choice.....me? Most of my money is in index.....over the years they have done very well for me.