Don't Let High Expenses Eat Into Your Returns

by Alan Lavine and Gail Liberman

Why let expenses cut down the return of your mutual fund investment?

The average common stock fund sports an expense ratio of about 1.5 percent. That's the percentage that taken out of your funds earnings to cover the cost of operating the mutual funds. 

This might not seem like much. In fact, most investors aren't concerned about fund expenses, according to recent surveys. But if you invest over the long term, expenses sure can add up!  

A study by Charles Schwab, a San Francisco-based brokerage firm, looked at how much $50,000 grew, assuming a 10 percent annual rate over 20 years based on three different expense ratios. The results show that over a period of 20 years, you have $65,809 more in a fund with the lowest expenses compared with the fund sporting the highest expenses.

* The $50,000 grew to $321,411 over 20 years, assuming just a
.25 percent annual expense ratio.
* The $50,000 grew to $293,359 over 20 years, assuming a .75
percent annual expense ratio.
* The $50,000 grew to $ $255,602 over 20 years, assuming a
1.50 percent annual expense ratio.

This can mean a lot when you retire. The low-expense fund can provide you with $4,000 in extra annual income assuming you invest it in something that pays 6 percent interest. That's an extra $329 a month to cover expenses!

Not all common stock mutual funds perform the same. Some well-managed funds with great long-term track records at fund groups like Fidelity, T. Rowe Price, Strong, Janus and others, may have higher expenses than other funds. But they also have delivered higher returns. 

So making fund expenses the sole criterion for picking a fund could send you in the wrong direction. However, if you have similar funds with similar long-term and short-term track records, go with the fund that sports the lowest expenses.

Not many funds outperform the stock market averages over the long term. Only about 35 percent of all funds beat the S&P 500 over the past 10 years. The average common stock fund grew at a 14.8 percent annual rate over the past 10 years. By contrast, the S&P 500 gained 17.4 percent annually.  

So if you have trouble finding a fund that can beat the market, just track-down a low-expense index fund. Index funds own stocks that are contained in an index, such as the S&P 500. Their expenses often run a mere .20 to .35 percent.

Alan Lavine and Gail Liberman are husband-wife personal finance columnists, journalists and authors. They are the authors of "The Complete Idiot's Guide to Making Money with Mutual Funds," published by Alpha Books. Their columns appear in newspapers throughout New England and the Southeast, as well as online. Their commentary on mutual funds and personal finance is carried by 200 radio stations nationwide every Sunday over Business News Network's Charles DeRose Financial Advisor Show.

More articles by Al and Gail can be found here.