Why Expense Ratios Matter

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"Income becomes irrelevant when you make the wrong financial decisions." - Your boy, Cade

Why Expense Ratios Matter

Fees.

The enemy of the average investor, but the saving grace for financial advisors and asset management companies.

These annual dues paid by the investor are based on the total assets they hold in a fund. Over time, the seemingly small percentages can make a significant difference in returns.

Every index fund guru will tell you that over a five-year period 75% of fund managers underperform, and this number only increases as you extend the time frame.

At 10 years? 83% are behind the S&P 500.

At 20 years? 94% have been left in the dust.

Don't take it from me, here is what Morning Star found.

Here is a numerical example to help you.

The Breakdown

The chart below shows an initial investment of $100,000 compounded at 8% annually over 20 years. Across the top of the chart are different expense ratios ranging from 0.03% to 2.00%.

The bottom two rows show the total amount of fees paid and your overall total return investment.

It adds up folks.

The difference between paying 0.03% and 0.50% is $23,700.

The difference between paying 0.50% and 1.0% is $50,420.

Remember this example is with an initial investment of $100,000 and no additional contributions. Imagine when one has hundreds of thousands, or even millions of dollars invested.

What to look for

The main factor that will play into the expense ratio of a fund is whether it is actively or passively managed. Actively managed funds will have higher costs because they require managers to spend more time and money managing the fund. (Wall Street bros have to get paid somehow).

Passively managed funds will have lower expenses since they are usually managed by an algorithm.

If a fund's strategy involves picking stocks you can bet it will have a higher expense ratio. ARKK for example, Cathie Wood's flagship ETF, has a fee of 0.75%.

With ETFs, you can expect those that track major indices like the S&P 500 to be passively managed. One of my favorite S&P 500 ETFs is VOO by Vanguard. It has an expense ratio of 0.03%. That means for every $10,000 invested you will pay $3 in fees.

$10,000 x 0.0003 = $3

Nowadays some funds advertise having "zero costs." For example, FZROX is Fidelity's Zero Fee Total Market Index Fund. Sounds great right?! Well, it is, and isn't.

Unfortunately, you can only buy FZROX through a Fidelity account, and since it is an index fund it also falls under the umbrella of being a mutual fund. This means that there is no intraday trading or option chains offered for it. Though, this doesn't matter for 90% of investors who are simply dollar cost averaging into it every month.

There is one last catch. Dividends on FZROX are only paid out once a year instead of quarterly. For those who place a high value on opportunity cost and like to reinvest dividends throughout the year, this is something to consider.

At the end of the day, it's not worth splitting hairs on 0.03%. On a $10,000 investment, it is only a difference in fees of $3.

I'm cheap, but not that cheap.

Cough Up The Fee

Sit down for this one, but sometimes coughing up the higher fee is the right decision. I'm going to throw hiring a financial advisor under this topic as well.

Here is why I say this. My Twitter DMs are full of questions. The answers to some of these questions are so reliant on the individual's income, expenses, debt, etc. that I would be doing them a disservice by answering without knowing more about their finances.

If you have a unique situation, or maybe you just don't feel like managing your investments, hiring a financial advisor is worth it.

Paying someone to invest for you is better than not investing at all.

Conclusion

Fees should not be ignored.

When analyzing funds or financial services take a look at the fee structure. What looks like a few numbers around a decimal point can make a difference of thousands of dollars down the road.

That said, don't be afraid to pay up if it improves your financial situation.

Till next time, Cade.

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Resources:

Simply Invest With ETFs - Learn the in’s and out’s of ETFs and why they are the simplest and most effective way to invest.

Turbocharge Your Dividends - Generate extra income by selling covered calls on your stocks and ETFs.

Tweet Hunter - Automate your Twitter and build an account that will pay you $100 a week.

Personal Capital - Track all of your investments in one place.

Nothing in this email is intended to serve as financial advice. Do your own research. Thanks for reading, if you have any questions, comments, suggestions, etc. about the email send me a DM on twitter.