Learn how to maximize your retirement savings and passive investment returns by looking at the expense ratio (fees) of your ETFs and mutual funds.
Higher than needed investment fees could cost you as much as HALF of your retirement nest egg over your lifetime in lost profits. There will always be some fee involved with investing, but paying more than needed will substantially decrease the amount you have at retirement.
Investment fees could cost you hundreds of thousands of dollars over your lifetime in lost profits. Below you’ll discover how and why, and how to do it better yourself.
High fees are not required. You can likely make a better return by investing in low-cost ETFs, on your own, than you could by buying high-cost mutual funds or having someone manage your money (because chances are, they won’t get you a better return than these ETFs).
In this article, I’ll discuss how high fees can hurt you. We’ll look at what high and low fees actually are. I will also discuss some low-cost ETFs to invest in.
Summary Points on ETF and Mutual Fund Fees
- Most people are paying someone (or a company), likely way too much, to provide returns that are sub-standard.
- A 2% difference in fees could reduce a retirement nest egg by half over 30 years. Even a 0.5% higher fee could cost about 25% of the retirement funds over a long period of time.
- There’s an easy option to invest on your own, costing about 0.03% per year. Compare that to 0.7% to 1%, which is also touted as low cost…but is 30x more expensive. That’s a huge difference and could equate to hundreds of thousands of dollars in lost profits over a lifetime. See the examples below.
- An Exchange Traded Fund (ETF) is pretty much the exact thing same your advisor is going to put you in, but they’ll charge you a much higher fee. Do it yourself, pay 0.03%, or they do it and charge you 30x more.
- Low-cost ETFs charging 0.03% outperform most advisors and mutual funds every year, and will continue to do so. Cut out the big fee and returns go up.
- Passive buy-and-hold investors are likely paying too much and getting too little. This article is about how to change that.
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How Much Investment Fees Are Costing You
As a passive (buy and hold) investor, which mutual funds or exchange-traded funds (ETFs) we own can have a massive impact on our retirement savings. A 1%/year difference in fees, or even less, can cost hundreds of thousands of dollars over a few decades. The numbers below illustrate how.
We want to own mutual funds, ETFs, and investments that go up over time, but we also want to reduce the fees and costs associated with those funds. If two similar investments return 10% in a year, but one charges a 1.5% fee each year while the other charges 0.4%, the one with the lower fee is obviously a better choice.
With the more expensive ETF/fund we end up with only 8.5% for the year, while the lower fee fund leaves 9.6%. If both funds are essentially the same and are going to produce similar returns year-over-year, then we are far better off switching to the lower-fee fund.
Don’t get suckered into high-fee funds. Their results likely haven’t beat the long-term successful track record of the low-fee funds discussed below. Compare the historical results before deciding if a higher fee is worth it.
The fee an ETF charges is called the expense ratio. For ETFs, you can find it listed on most financial sites. Here is an example from https://finance.yahoo.com/. If you own mutual funds, check your statements. The expense ratio should be on there.
It’s Only 1% or 0.5% Difference. Is My ETF or Mutual Fund Still Too Expensive?
Even small differences in fees over many years can add up to HUGE amounts of money. This is because of compounding. If a mutual fund charges 1% more than a comparable ETF, we aren’t just losing out on 1% per year. We’re also losing out on the money that 1% could have made, year after year.
Say a fee costs $100 this year. And next year we make 10% in that fund. That $100 that was taken from the account would have been worth $110 (had it not been taken). But then they take another $100 for the next year. The next year, that original $100 would have been worth $121, the $100 taken last year would have been worth $110 (assuming a 10% rate of return). So over two years we actually lost $231, not just the $200. Add on a few more years and the numbers escalate quickly.
Let’s look at some examples, assuming an ETF makes 8% per year on average.
The average return for the last 100 years for the S&P 500 index is 10.3% per year, so 8%/year is a conservative estimate of what the average low-cost S&P 500 ETF can make if investing for the long term.
0.3% Difference in Expense Ratio
Assume one fund charges 0.4% and another charges 0.1% per year.
If we deposit $100,000 and let it grow for 30 years at 7.6% (which is 8% less a 0.4% fee), we have $900,260 at retirement. In the lower-fee fund, the yearly return is 7.9% (8% less 0.1% fee), and we end up with $978,685.
With the higher fee ETF we’ve lost $78K for nothing, more than most people make in a year! Just gave it away. Put another way, we lost $2,600 per year or about $200 per month.
And that is only a 0.3% difference. Imagine if the difference is bigger.
1% Difference in Investment Fees
If someone is charging us 1%, or more, we lose much more.
$100K invested over 30 years would be worth $995,145 if making 7.96% (8% less a 0.04% fee). That’s an almost 1,000% return over the time period.
If someone takes 1% in fees, the return is down to 7% per year, and we end up with $761,226, about a 760% return. We missed out on an extra 240%.
If holding for 35 years, in the higher fee fund we miss out on 391% and almost $400K! Over 35 years, more than $11,190 was unnecessarily taken from us every year (average).
And that doesn’t even include additional funds we may add over the years. Making monthly contributions to our retirement savings is recommended. Add in those contributions, which would also compound, and the difference gets even bigger. In some cases, paying higher fees could end up costing about half of the retirement nest egg.
If you want to do some comparisons yourself, here is an Investment Compounding Calculator Excel spreadsheet where you can play with various numbers and see how various fees and returns could affect you over the years.
Some Investments Are More Expensive Than Others
The point is not the fee itself. Sometimes we pay a higher fee for a certain product because it’s a more specialized fund. The point is, compare the ETF and mutual fund fees and returns to other funds. There’s no point in giving up percentage points for no reason.
If we are going to pay a higher fee for a specialized fund, it better be worth it. Make sure the track record justifies the higher cost.
Over time, investing in low-cost index funds is a great way to grow wealth…at least according to Warren Buffett who knows a thing or two about compounding money.
A Simple Non-Expensive Passive Investing Option
If your broker, fund, or ETF isn’t beating the long-term 10% average return of the S&P 500, then consider buying a low-cost ETF that mirrors the S&P 500.
The Vanguard S&P 500 ETF (VOO) is one of the cheapest options, costing only 0.03% per year to be invested.
In Canada, the BMO S&P 500 ETF (ZSP) tracks the S&P 500, in Canadian dollars, for a fee of 0.09%.
I don’t make things too complicated when it comes to my long-term investing. I contribute to my “self-directed” retirement account monthly and add to my ETF positions by buying more.
The S&P 500 is an index composed of 500 large US companies. ETFs or mutual funds that invest in the S&P 500 are called index funds, because they are tracking or buying the same stocks that are in the S&P 500 index. The company running the index-tracking fund doesn’t need to do much work. There’s no research; they just hold the same stocks that are in the index, which is determined by Standard & Poor’s (S&P).
There are other indexes as well, such as the Nasdaq 100, and the Dow Jones Industrial.
A Bit More Diversification
Owning an index fund, like VOO or ZSP (Canada) is great. It is low cost, and historically the S&P 500 has produced solid yearly gains compared to most other benchmarks and fund managers. THERE WILL BE DOWN YEARS, but historically, over the long run, just buying and holding has produced about 10% per year over long periods of time.
There are also many other ETFs. Technology ETFs have a history of producing bigger returns than the S&P 500, but the ups and downs are also bigger.
If you want a list of specific low-cost ETFs to invest in, I provide it in my Passive Stock Investing Using ETFs eBook. It covers all the basics for investing in stock ETFs, as well as the top low-cost funds for Americans and Canadians.
By Cory Mitchell, CMT
Disclaimer: Nothing in this article is personal investment advice, or advice to buy or sell anything. Trading is risky and can result in substantial losses, even more than deposited if using leverage. I am not a financial advisor or a retirement planner.