Why does mutual fund fees matter?

[free4now]

The question underneath "do fees matter" is "do higher fees get you a better return".

People who have studied that question analytically have found that lower fee funds give better returns than higher fee funds.

People who study the question anecdotally often find that high fees increase returns.

 

[cute fuzzy bunny]

OK, now I understand. I have accounts at Vanguard as well. They state my "Personal Rate of Return" is 18.2%. But that is clearly the return for the last 365 days and not year-to-date. Vanguard does not even have a YTD figure shown anywhere under the "Performance" tab.

Negatory...the numbers I gave are accurate. I used a year to date number I got from somewhere on the vanguard site (I'll look later, have a baby climbing on my head right now), and the 3 year number came from the "personal rate of return" page.

I'm a flagship customer, so I might have something showing up that non flagship customers dont...I've been made painfully aware of that a couple of times when I was telling someone to look at something "right there on that page" and I had it and they didnt.

 

[mrbill]

Do mutual fund fees matter? Only one thing matters: How much money do you have now...and how much money did you have a year ago. If you like the answer...then who cares? High fees, low fees, it doesn't matter...if the fund doesn't perform up to your standards, get another fund.

 

[mb]

Van,

Vanguard Star is a balanced fund (stocks and bonds) and Price Cap Appreciation is a value fund.  Comparing them is an "apples to oranges" comparison.  If you want to look at managed funds you should be comparing balanced funds to other balanced funds and a balanced index and similiarly for value funds, not to each other.

If you haven't already done it you should determine your asset allocation before you start selecting funds.

Both Star and Cap App are good funds.  The real question is do you want a balanced fund of a value fund and that goes back to asset allocation and risk tolerance.

MB

 

[gindie]

mb,

TRP Capital Appreciation is a balanced fund. It is listed by Morningstar as "Moderate Allocation". While its equity portion is value-leaning, it comprises only 60% of the fund. The rest is cash and convertibles.

 

[mb]

Opps, you're right gindie. But with less than 1% domestic bonds it still seems like it is pretty different than Star.

MB

 

[youbet]

Back to Van's original question ... it appears the consensus is, reluctantly, that IF you assume a managed fund can continue past success, AND that performance consistently beats the relevant benchmark and competing funds, the higher fees do NOT matter ... since the performance data is measured net of fees.  In other words, rare as they may be, there is an occasional managed fund that can be worth their fees.

Is that a correct summary, recognizing the signficant qualifiers?

Hey, sounds good to me.  IF all those assumptions are true and consistent and lasting, I'll agree. 

You could go to the same place with financial advisors.  If a high fee, commission based FA, despite charging you a ton of $$$, magages your money so that your returns, net of his/her fees, exceed what you would have gotten otherwise, then the FA was a good deal.

It's all in the assumptions.

The danger is that Van's assumptions seldom happen and that giving the "fees don't matter" story to inexperienced investors could lead them to paying unnecessary fees at best or shark attacks at worse.  It would be kind of like telling a teenager that if he/she doesn't get in an accident while driving drunk/high, then driving drunk/high is OK.   

 

[youbet]

Van,

Vanguard Star is a balanced fund (stocks and bonds) and Price Cap Appreciation is a value fund.  Comparing them is an "apples to oranges" comparison. 

MB makes an excellent point.  Fees vary by asset class.  So, Van, when you are comparing fees, do so within asset class. 

For example, many international managed funds outperformed the S&P 500 index for the past 12 months.  Many international managed funds have higher expense ratios than S&P 500 index funds.  But, it wasn't the higher expenses that caused the superior performance of the managed international funds, it was the higher performance of the underlying stocks during this time.

Best not to compare fees from asset class to asset class but rather within asset classes.

 

[free4now]

Risk (volatility) is usually the "secret sauce" that explains how some funds with high expenses perform as well as or better than funds with low expenses.   In other words if two funds in the same class provide the same returns, but one has greater fees, the one with the greater fees is probably more volatile.

I could make a fund by highly leveraging index investments that would beat the indexes in all years when the market rises and inflation is low, even charging 5% expenses.  Over the bull run we've had, it could have beaten the indexes on 1 year, 5 year, and 10 year results.   But the high leveraging and fees would mean it will get blown to pieces in a serious bear market.   

 

[doushioukanaa]

Risk (volatility) is usually the "secret sauce" that explains how some funds with high expenses perform as well as or better than funds with low expenses.   In other words if two funds in the same class provide the same returns, but one has greater fees, the one with the greater fees is probably more volatile.

You may be right about that, but if you can find a fund with comparable or superior returns but with lower volatility than its peers, you should be willing to pay a bit more for those benefits.  This a major part of the case for well managed funds versus index funds.

I could make a fund by highly leveraging index investments that would beat the indexes in all years when the market rises and inflation is low, even charging 5% expenses.  Over the bull run we've had, it could have beaten the indexes on 1 year, 5 year, and 10 year results.   But the high leveraging and fees would mean it will get blown to pieces in a serious bear market.   

This is a great explanation for why you shouldn't buy into a hedge fund.  Those funds charge outrageous fees, and their oversized returns are simply due to all the risk that that they pin on you, the investor.  The managers have a big incentive to roll the dice, and then they keep way too much of the upside for themselves.

 

[samclem]

. . . but if you can find a fund with comparable or superior returns but with lower volatility than its peers, you should be willing to pay a bit more for those benefits. This a major part of the case for well managed funds versus index funds.

But, at best, it is only possible to find funds with a history of "comparable or superior returns but with lower volatility". Then, you'd have to figure out the reason for the better performance under those particular market conditions (there must be a reason). All of which assumes that those same market conditions will apply in the future (they almost certainly won't). Then you have "manager risk" (the guru will quit someday). And style drift (the guru or his elves gets a new idea of how to beat the market). Now add the increased expenses. Sure, sometimes managed funds win over particular time periods, but picking them in advance is hard--and some would say that attributing this pick to skill is just not backed up by the evidence.
So, I have mostly low ER index funds. (But, quantitative funds do have some appeal . . .)

 

[doushioukanaa]

But, at best, it is only possible to find funds with a history of "comparable or superior returns but with lower volatility".  Then, you'd have to figure out the reason for the better performance under those particular market conditions (there must be a reason).  All of which assumes that those same market conditions will apply in the future (they almost certainly won't).  Then you have "manager risk" (the guru will quit someday).  And style drift (the guru or his elves gets a new idea of how to beat the market).  Now add the increased expenses.  Sure, sometimes managed funds win over particular time periods, but picking them in advance is hard--and some would say that attributing this pick to skill is just not backed up by the evidence. 
So, I have mostly low ER index funds.  (But, quantitative funds do have some appeal . . .)

Sometimes the superior risk/return characteristics may be due to more than just market conditions or luck.  Some fund families are just better managed overall. 

Your warnings about manager risk and style drift are very key.  That is why if you choose a managed fund, it should be team managed (4 or more people) by a fund company that has good retention of those managers, and it should be by a firm with a track record of not changing the mandate of their funds.  It's why I choose Capital Group's American Funds for the managed fund portion of my portfolio.   There is no single "guru" at the helm of a Captial Group/American fund, and they rarely if ever change the mandates of their funds. 

The only downside I can see to them is that they are so successful with their formula that they are getting quite large (I will not buy their small cap fund for that reason).  Also, unless you can hit one of their large breakpoints the upfront loads on the A shares can be quite burdensome.  However, their team approach with good manager retention allows them to manage the growth well, and the annual fees on their A shares are a small price to pay for the excellent risk/return characteristics. 

I guess I should also disclose I personally know one of the Captial/American fund managers, a personal friend with whom I went to business school, and he is somebody whom I trust and am very impressed with.  I know how hard he works to get the performance out of his portion of their funds, and I know he is highly motivated to stay there and to keep the performance going well. This gives me the added confidence because I know I'll get a phone call if he ever decides to yank his own money out of the funds for some reason.