Do you know your mutual fund's Expense Ratio?
There are so many people waiting in line for a piece of your hard-earned IRA or 401K investment. But few are more insidious, or more costly, than a mutual fund's so-called Expense Ratio. Make no mistake about it...you should never invest in any mutual fund without considering this important number. Granted, your plan administrator has probably steered you away from any risky funds (and I mean both negative and positive risk), but these expense ratios still can be devastating.
Where IS this magic expense ratio?
Based on how easy it is to find, you might think they didn't want you to find it. But every mutual fund has an expense ratio, and it must be listed somewhere. On www.Finance.Yahoo.com you can enter the fund's ticker and click "Get Quote" to see the summary info. If you enter VIFSX, a Vanguard fund which is designed to track the S&P 500, you can find the Total Expense Ratio is listed as 0.07%. If you believe holding Gold stocks will protect you, check American Century's BGEIX, with a ratio of 0.70%. Or maybe you like to support green (like me) so you check out Firsthand Alternative Energy (ALTEX) with a whopping 2.15% (!)
Aw...what's a couple of percent between friends?
You might think it doesn't make a whole lot of difference if a fund charges 0.2% versus 1.0% or even 2.0%. But we're talking about taking this amount off-the-top, every year! So, even if your fund goes down 10% for a year, you'll get charged an extra X% on your entire principal, just for playing the game. Look what happens to $1,000 over 10 or 20 years. We'll assume that all three funds have equal performance of 5% gain per year:
| Expense ratio (%) | 10 years | 20 years | Your Gift (20 yr) |
| 0.00 (Baseline - no expenses) | $1,629 | $2,653 | 0 |
| 0.07 (VFINX - S&P 500) | $1,618 | $2,618 | $35 |
| 0.70 (BGEIX - Gold) | $1,524 | $2,321 | $332 |
| 2.15 (ALTEX - Alternative Energy) | $1,324 | $1,754 | $899 |
This is not something you can ignore! Whether you're paying 25% tax when you withdraw this money from an IRA, or have already paid 25% tax before you put it into a Roth IRA, after 20 years, you've effectively given away another 34% of your hard-earned cash. In fact, you've given more money to them than they have earned for you! Please promise me you'll look for that expense ratio next time!
Sense in Expense Ratios?
I wish I had an explanation for why you're just
dying to make this gift to your mutual fund. Do they spend all that on the best
fund managers for these fund? Do they expect these funds to have outrageous
returns, such that I won't care? Or do they have some other reason why they just
don't want me to invest? I am certain there are so-called reasons, but I really
don't know if I would believe them. There is a reason these are included as
"fees" ...they probably have little or no bearing on their actual "expenses.
Bottom line...know what these charges are, large or small. You'll generally find
that index funds are less expensive, and that Vanguard's funds have the lowest
expense ratios. They deserve real credit for that, maybe in the form of your
business.
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