Why does mutual fund fees matter?

[Van]

Here is a true newbie question. I have read lots of posts about the significance of mutual fund expenses. Since the performance numbers of mutual funds have already reflected funds expenses (am I correct?), then a high cost/high performance fund is prefered over a low cost/low performance fund. Am I missing anything here or are we making it more complex than it really is?

 

[LovesLife]

How do you know what the future performance will be?

 

[REWahoo]

Since the performance numbers of mutual funds have already reflected funds expenses (am I correct?), then a high cost/high performance fund is prefered over a low cost/low performance fund. Am I missing anything here or are we making it more complex than it really is?

To LL's point, history tells us yesterdays "high cost/high performance" fund will likely be tomorrows "high cost/average or low performance" fund. Since cost is the only constant, better to go with low cost. And since managed funds have a questionable track record vs. index funds, the best bet of all is to go with low cost index funds.

 

[youbet]

Van:

When I was last dealing with Ameriprise (formerly named American Express Financial and before that Investors Diversified Services), the sales person Financial Advisor used exactly that logic on me.  He told me paying sales loads and high expensives were OK because those charges would be buying better performing funds that would more than make up for the charges.

When I checked historical performance, I found that was seldom the case.  The funds he was trying to charge me 5.75% to purchase had actually underperformed their index benchmarks for the 1, 3, 5 and 10 year prior periods.

Have you actually checked the performance of the high cost funds you are considering against relevant benchmarks?  Historically, high cost funds have not been able to match the performance of low cost funds over time, although there will always be some exceptions over limited time frames.  The problem is identifying those exceptions apriori.  Therefore, most informed folks go with low cost funds.    

 

[cute fuzzy bunny]

Basically if you look at longer term records of most mutual funds, costs over the long haul matter a lot.

Granted a fund that charges 2% and has a 20% annual return over 20 years is going to be hard to pass up.

Looking at long term equity results, you're getting something in the 8-9% range on average. Inflations going to eat 2.5-3.5% of that, perhaps more depending on where you live. If you're in the withdrawal stage, and believe in the 4% routine (or 5 or 6), you can see that you're pretty much out of that 8-9% gain. Tack on a 1%-2% mutual fund fee, and you better have a good idea of how you're going to make up that difference.

If I can get close to, or better performance, from a cheap fund than an expensive one, i'm automatically 1-2% ahead. Thats a tough initial lead to overcome year in, year out.

For bond and other funds with lower than equity returns, cost is even more crucial.

I'm paying about .18-.19% expenses on my portfolio. I've not seen ANY collection of funds of the same type and the same risk levels that have better long term results.

But there are a LOT that are about the same or a little worse that are charging a full percent or more higher fees.

 

[mathjak107]

I'm paying about .18-.19% expenses on my portfolio. I've not seen ANY collection of funds of the same type and the same risk levels that have better long term results

fuzzy im interested in seeing what your using...im looking to eventually leave the newsletter i follow and replace my fidelity funds averaging around .89 with lower cost etf's...i just havent been able to come up with a succesful mix on my own that beats what im getting even at the higher expense

 

[cute fuzzy bunny]

I'm a little confused about the newsletter I hear you mention, so I'd have a hard time framing what I'm doing in the context of your success.

Without wandering too far from the original topic, although we're in the vicinity, can you answer a couple of questions?

- Is this just one "newsletter" you're using, or one that has changed author, name, intention, etc over a period of time? If so, whats the current authors term and stated intentions for the investor? Stable principal? High income? Both? Something else?

- How long have you actually had money invested

- You mentioned (I think) a 20 year highly successful record for the newsletter...was this actually time that the newsletter and its followers had real money invested or is it something thats been around for ten years with real money invested, with 10 more years of "backtesting" to show what the results would have been?

My approach probably wont be for many people that arent in the accumulation phase and dont have a strong stomach. The working wife creating a small income flow and covering health care makes an enormous difference in the ability to push the volatility slider bars out a little bit.

Roughly:

IRA:
20% total stock market
5% small cap value

Taxable:
40% Target retirement 2045
25% Windsor II
5% High yield corporate (which will go away in a couple of months)

Aside from this, we also have a cd ladder and money market holdings amounting to a couple of years of spending needs. Half of that cash will be invested once I see a buying opportunity.

This is about 80% stocks, 10% bonds, 10% cash by total view.

Stocks are about 90% domestic, 10% international.

I'm up about 18% year to date. Average annual returns over the last 3 calendar years is roughly 14%. Considering in the oldest of those 3 years, most of my holdings were in Wellesey, thats not too shabby.

 

[maddythebeagle]

Another point: some of these active managed funds should be compared to a comparable index benchmark. Some of them are just comparing themselves to the sp500 index.

 

[mathjak107]

i have been in the newsletter since 1987....same author .....goal is basically to do about the same as the s&p 500  with less risk.....i use this newsletter for my long term growth money......i do use another for kind of an income and preservation mix for shorter term money..its basically the longer term id like to swing to etf's eventually

 

[mathjak107]

fuzzy 18% after friday is excellent................
the aggressive growth mix in my newsletter is up about 14% but i dont use that anymore....im getting to old for the swings ha ha ha

 

[cute fuzzy bunny]

So you've had actual cash invested in the newsletter since 1987?

Which risk are you trying to avoid? Volatility, loss, or

If its volatility, I believe the vanguard asset allocation fund closely mimics the return of the s&p500 with lower volatility. At least thats what its supposed to do

 

[bosco]

i have been in the newsletter since 1987....same author .....goal is basically to do about the same as the s&p 500 with less risk.....i use this newsletter for my long term growth money......i do use another for kind of an income and preservation mix for shorter term money..its basically the longer term id like to swing to etf's eventually

Is your newsletter, by any chance, Fidelity Insight? (the gain numbers look familiar)

The growth portfolio of this newsletter has been amazing dating back to 1986 (even made 20% or so in 1987, despite the crash), and all with less average risk than the S&P.

If so, why would you be so intent on switching into etfs? The fund recommendations on insight are not static--they change as conditions, managers, etc. change so comparing these recommendations to a b&h portfolio is not necessarily valid. And there are no transaction expenses with Fido mutual funds. There may be better tax characteristics of ETFs, but other than that why abandon a winner?

I realize that there is a strong "party line" on this forum to buy and hold low-expense index funds. I even believe it is a good strategy. But I don't believe it is the only winning, sensible, or even always the best strategy.

I don't follow the model portfolios in this newsletter, but I certainly read it. An interesting exercise is to use stockcharts.com to plaster ETF performance on top of Fidelity sector funds. In many, the Fido funds have done better (even with their high expense ratios). Admittedly, most etfs don't have a long history.

If something is working for you, don't be quick to abandon it for something else. How about keeping half your funds as they are and running a comparison over a couple of years?

 

[LOL!]

I'm a little confused ...

I'm up about 18% year to date. 

Given your listed portfolio and the relatively small allocations to international and small cap, I am also a little confused by your "up about 18% year to date."  I do not believe that can be a return on investment from midnight December 31, 2005 to anytime you use in 2006 before May 12th. 

Maybe it's a year-over-year return?  Or you have been trading?  Or you bought/sold options?  Or you added to your holdings and you're doing Beardstown Ladies math?

 

[doushioukanaa]

Don't forget about volatility....If you can get the same return after expenses without volatility, you are going to be better off. The indexes by definition match the market's volatility. The impact is all the more significant if you are withdrawing from the portfolio. Here is a study from the American Funds site that illustrates the concept:

http://www.americanfunds.com/planning/news/fund-measure-up.htm?referrer=shhp_news_fund-measure-up

To the extent you do choose a managed fund, make sure it is not so personality driven that you're left with a dud once the superstar leaves -- then you are faced with the tax implications of selling or experiencing lackluster performance. This is why I choose American Funds over other managed funds. The A share loads are outrageous if you don't meet the breakpoints, but the annual costs are competitive. They have excellent retention of fund managers and have a "portfolio counselor" approach that makes the fund family less vulnerable to personality changes. They also don't waste a lot of money on advertising, but on the downside the funds are getting very large. They manage the growth by continuing to subdivide the fund management responsibilities.

 

[Van]

Thanks for your answers. Actually, here is my quandry. I am considering MPT for the taxable account but planning to use a balance fund for the pretax account (amount here is not great enough to justify the hassles of annual rebalancing). I am considering Vanguard Star fund and Trow Price Capital appreciation. The Trow Price fund has an expense ratio of .76 compared to a much lower ratio for Star. However, over a ten year period, Trow out performed Star by a factor of $6300 per $10,000 invested. Trow has performed excellently thru the 2000 bear market with very narrow fluctuations. Am I over looking any other factors in leaning toward Trow over Star? I realize that there is no guarantee of Trow's excellent performance into the future, neither is there any guarantees of Star's future performance. This is why I raised my original question regarding the mutual fund fees.

Van

 

[doushioukanaa]

I'm impressed with the T Rowe Price returns, especially being positive in 2002, but bear in mind it is a US only fund.  Also, there is sole fund manager who has been there since 1972.  That's 34 years.  Is he close to retiring?  What is the succession plan?  I'm reluctant to go with any personality driven managed fund. Remember when Peter Lynch left Magellan? They have a new manager again, and a lot of turnover causing capital gains taxes to hit them. Maybe the retooling of the fund will be great, but how can one have confidence that it will when the new person has no track record with the fund?

 

[mathjak107]

Is your newsletter, by any chance, Fidelity Insight? (the gain numbers look familiar)

The growth portfolio of this newsletter has been amazing dating back to 1986 (even made 20% or so in 1987, despite the crash), and all with less average risk than the S&P. 

If so, why would you be so intent on switching into etfs?  The fund recommendations on insight are not static--they change as conditions, managers, etc. change so comparing these recommendations to a b&h portfolio is not necessarily valid.  And there are no transaction expenses with Fido mutual funds.  There may be better tax characteristics of ETFs, but other than that why abandon a winner? 

I realize that there is a strong "party line" on this forum to buy and hold low-expense index funds.  I even believe it is a good strategy.  But I don't believe it is the only winning, sensible, or even always the best strategy.

I don't follow the model portfolios in this newsletter, but I certainly read it.  An interesting exercise is to use stockcharts.com to plaster ETF performance on top of Fidelity sector funds.  In many, the Fido funds have done better (even with their high expense ratios).  Admittedly, most etfs don't have a long history. 

If something is working for you, don't be quick to abandon it for something else.  How about keeping half your funds as they are and running a comparison over a couple of years?

very good,yes it is fidelity insight,been an origional subscriber going back to the beginning...excellent performance and so far i havent been able to come up with a low cost alternative...but with longer track records of etf's starting to show im always looking to cut expenses,...lets face it even at .89 im paying fidelity over 10,000 a year with all we have with them so lower expenses would be nice but not at the risk of loosing return....

 

[Nords]

very good,yes it is fidelity insight,been an origional subscriber going back to the beginning...excellent performance and so far i havent been able to come up with a low cost alternative...

How does the newsletter stack up to Hulbert's rankings?

 

[mathjak107]

not sure how it measures up ,i never looked. but im very curious....there are newsletters for fidelity funds such as fidelity monitor which i also get but they are way more aggressive than i want to be at this point but non the less they do have a slightly higher return almost year after year

 

[Craig]

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?

 

[Van]

Thank you Charles. It looks like the question remains basically unresolved. We have many supporters of low fees. We also accept that we can not predict the future performance.

Since most early retirees favor a balance approach (this means that it goes down the middle and does not favor a style that may be in or out of favor). Can we come to an agreement that past performance may be relevant and warrants a higher fee? It seems to me that low fees may not be the holy grail after all.

 

[Craig]

I think all you're looking for immediately is ... when those performance stat's say they are "net of expenses / fees", is that accurate ... and if so, isn't it net performance we should be comparing?

And, I believe the difficulty in answering your question isn't a matter of confusion over the question ... it is an understandable reluctance to add any more fuel to the managed funds pile.  Most managed funds do not beat index funds with low fees.

But I believe your basic premise is correct ... IF a fund manager could beat indexes consistently, over decades, and charge 3%, would we mind paying that fee?  No, I don't believe we would.  Berkshire Hathaway comes to mind ...

 

[Nords]

Can we come to an agreement that past performance may be relevant and warrants a higher fee?

Only if they give refunds when future performance falls short of past performance.

Take a look at the thread where I'm selling Tweedy, Browne for an ETF. Tweedy's had a good run but the cards are heavily stacked against them and I don't think their active management is necessary any more.

We'll see how things look in 10 years. However Tweedy's not only fighting their benchmark now, they're also about 0.8%/year behind the ETF. That's 8.3% over a decade...

 

[cute fuzzy bunny]

Given your listed portfolio and the relatively small allocations to international and small cap, I am also a little confused by your "up about 18% year to date." I do not believe that can be a return on investment from midnight December 31, 2005 to anytime you use in 2006 before May 12th.

Maybe it's a year-over-year return? Or you have been trading? Or you bought/sold options? Or you added to your holdings and you're doing Beardstown Ladies math?

18% is what vanguard says my year to date returns are; all my money is with them. Therefore it is whatever they calculate it to be.

I have in fact changed my portfolio quite a bit over the last couple of years. Earlier this year I sold some REITS, Emerging Markets, Energy and Precious Metals holdings that I thought had had the bulk of their day.

I think I'll sit in what i'm in for a while. My "luck" just has to run out sooner or later...

 

[LOL!]

18% is what vanguard says my year to date returns are; all my money is with them.  Therefore it is whatever they calculate it to be.

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.