Expense Ratios on Mutual Funds

**disneysteve** · 12-25-2007, 04:09 PM

Originally posted by atomicrc11 View Post

I've been happy with the performance of the funds I have, but is there really a compelling reason I should go through the paper work to get the lower expense ratio on the IRA? So far my funds have performed a bit better than the Vanguard Fund, so I guess the expense ratio has been a wash for now. Any help is appreciated.

Ultimately, the bottom line is you want the best performance, period. Your fund with the 0.86% expense ratio has to consistently outperform the 0.21% fund by 0.65%/year just to break even. Sure, that's possible, but in the long run, odds are you will come out ahead in the lower expense fund (assuming we are comparing similar types of funds). Of course, you shouldn't choose a fund simply based on the expense ratio, but if all other things are pretty much equal, go with the lower expense ratio.

**Broken Arrow** · 12-25-2007, 05:31 PM

Generally speaking, anything 2% on up is considered high, anything between 1% to 2% is considered average, but anything below 1% is low. But please remember that this is arbitrary, and it really depends on the context of what kind of investments you're talking about.

Now, is your 401k in Fidelity, or do you have only the funds? Sounds like only the funds? Otherwise, Fidelity is one of the biggest brokerages out there, and boasts one of the biggest-- if not the biggest-- selection of mutual funds.

Vanguard is indeed well-known for their low expenses. While we do not have any control over market performance, expenses and fees are certainly one of those things we can have control over. As such, and at the risk of showing a bias here, I'm an advocate of low-cost investing, and that naturally puts Vanguard on the top of a very short list.

Target retirement funds are actively managed, and as such, will never be as low as passive index funds for example. However, that doesn't mean it's a bad option per se. At 0.86%, they're worth it if you don't plan on managing your portfolio.

However, for those who are willing to get hands-on with it, I don't find target funds all too appeal personally. As a Fund of Funds, it's not flexible and you forego any special incentives such as Foreign Tax Credits in your international investments. You can pretty much roll your own that mirrors it and yet still have the lowered expense ratios. When you consider that in your long-term investments, it could make rather noticeable difference in the end.

The only downside (if can call it that) is that you have to rebalance it yourself on a regular basis. However, as an annual or semi-annual exercise, I don't think it's that bad at all.

So, I guess the answer as to whether target retirements are a good idea or not really depends on how involved you would like to get with your portfolio. And that's something you'll have to honestly ask yourself.

Finally, if you do plan on getting your hands dirty with your own investment portfolio, you'll want to ask yourself why your portfolio is performing better than the Vanguard fund for example. Perhaps it's the international funds mixed into there that's beating out Vanguard's domestic index? Also, how close is the gap in terms of net return after expenses are factored in?

Not knowing why something is doing "better" or "worse" can and will cost you money someday. Also, to reiterate a well-worn investment advice, "Past performance is no indication of future performance."

Bottom line: I don't think 0.86% is all that bad. It could be better, but it could be worse too. It's up to you to decide whether you're willing to devote the time and energy to actively manage your portfolio, to get better returns and lower your expenses as well.

**disneysteve** · 12-25-2007, 05:44 PM

Originally posted by Broken Arrow View Post

Target retirement funds are actively managed, and as such, will never be as low as passive index funds for example.

This isn't true, at least not with Vanguard. Their target funds are just baskets of index funds. They aren't actively managed and their expense ratios are very low at 0.21%.

**Broken Arrow** · 12-25-2007, 06:09 PM

Originally posted by disneysteve View Post

This isn't true, at least not with Vanguard. Their target funds are just baskets of index funds. They aren't actively managed and their expense ratios are very low at 0.21%.

Thanks for pointing that out, Steve. I should have clarified that actively managed funds are not as low as passive index funds WITHIN that brokerage.

Vanguard's own S&P 500 index fund is at 0.18%, but their target retirement funds range from 0.19% to 0.21%. I admit the differences there are small, but I don't think I have been incorrect, just not clear enough.

Of course, if we are to compare from brokerage to brokerage, then yes, the differences can be quite startling. Fidelity's 0.83% doesn't compare to Vanguard's 0.21%. Especially when it comes to long-term investing, is it any wonder why Vanguard's so popular?

Still, for the sake of fairness (and to prevent being mauled by any actively managed fund fans out there

), I do believe in looking at the net return. Actively managed funds aren't bad if it can outpace the difference in the expense ratios, or more importantly, if it is the most suitable fund for your portfolio and investment style. The target retirement fund is an example of that (for those who don't want to get involved with investing).

**sweeps** · 12-25-2007, 06:39 PM

Vanguard's target retirement funds are not actively managed. The target retirement fund can't be as low as the S&P 500 fund because it includes other components. The emerging markets index fund for example has a 0.42% expense ratio.

**Broken Arrow** · 12-25-2007, 06:44 PM

It's not? Does that mean rebalancing is not part of the expense then?

**sweeps** · 12-25-2007, 06:56 PM

Someone rebalances it, just like someone rebalances an S&P 500 index fund. In both cases they're just following predefined indexing criteria. There is little human judgment involved.

It is true, however, that the expense ratios of the target retirement funds are artificially low. There is still some effort involved in indexing the indexes. Vanguard (and the other companies) are waiving that expense.

**Broken Arrow** · 12-25-2007, 07:12 PM

From what I understand, index funds are passive because all the legwork is "out-sourced" to the index committee doing most of the valuation work for them. Hence the cheap ER. The brokerages will then tweak it a little to get the desired low cost, but I don't think that's not a big expense to do so.

However... I don't think that's exactly the same thing as a brokerage rebalancing a target retirement fund (such as increasing the % allocation of bond funds while lowering the equities over time, even if these funds in the target fund are index funds).

Still, I confess I don't really know how much that factors into the expense ratio, or if at all (since it could be considered trivial and is waived as you say). For that matter, does the act of rebalancing qualify it as an actively managed fund? I could be wrong, but I was under the impression that if someone has to watch over it, even if it's just to rebalance it, then it would qualify as an actively managed fund.

Then again again, maybe this issue is ultimately a trivial matter of semantics, and I agree that what really matters here is that the ERs are quite low indeed. But yeah, I could be wrong about all this, and that's fine. Learn something new everyday. Thanks.

**disneysteve** · 12-26-2007, 04:33 AM

Originally posted by Broken Arrow View Post

Still, for the sake of fairness (and to prevent being mauled by any actively managed fund fans out there

), I do believe in looking at the net return. Actively managed funds aren't bad if it can outpace the difference in the expense ratios, or more importantly, if it is the most suitable fund for your portfolio and investment style.

I agree. I hold both index and actively-managed funds in my own portfolio. I also invest with several different companies. I believe in picking what I perceive to be the best funds, not just the best funds within one company's offerings.

**disneysteve** · 12-26-2007, 04:35 AM

BA - I don't know the details either, but it seems to me that rebalancing a target fund could be done by a fairly simple computer program and wouldn't need a highly paid human advisor. I have no idea how Vanguard and the others actually do it, though.

**humandraydel** · 12-26-2007, 07:29 AM

Originally posted by disneysteve View Post

BA - I don't know the details either, but it seems to me that rebalancing a target fund could be done by a fairly simple computer program and wouldn't need a highly paid human advisor. I have no idea how Vanguard and the others actually do it, though.

I'd guess this is how they do it. It's true that the TR funds are just a rebalanced basket of Vanguard's other index funds. So, by definition, the expense of the TR is just the expenses of the underlying funds. Vanguard even lists the expense ratio for the TR as the "Average Weighted Expense Ratio." The interesting thing is that the 2035 fund lists the ER as 0.19% but if you actually calculate the average weighted expenses, it comes out to 0.21% - but at that point, it's just splitting hairs.

**humandraydel** · 12-26-2007, 07:34 AM

Back to the original post though - personally, I wouldn't pay more than 1% for a fund. But I'm a big proponent of Vanguard index funds. For some more specialized funds like international small cap I would be willing to pay 1.25%, but not more. But for most things like large cap or bond funds, it doesn't make much sense (to me) to pay more than 0.3% or so.

**atomicrc11** · 12-26-2007, 09:06 AM

Thanks for all the posts. Basically, my 401k is at Fidelity, so I don't have a choice other than using Fidelity funds. My Roth IRA is in Banc of America Investments with a Target Retirement 2040 fund. It is made up of funds from Columbia Investments. At this point, I don't want to manage my own portfolio, mainly because the sum is small, around 5k and that doesn't even meet the minimum for two funds at most brokerages. I am planning on going with the Target Date fund at least until I have 100k saved up. Then having multiple funds wouldn't be an issue as I would meet minimum investment amounts and have a high enough balance to avoid fees.

One thing I did notice is most of the Vanguard fund VTIVX has most of it's investments (60%) in Vanguard's Total Stock Market Index fund. With the Banc of America fund BFHZX, it has large cap, mid cap, small cap, international and bond funds from the Columbia family of funds in it. Is it better to go with something that has more in the general stock market or are all these underlying funds in BoA helping get a better return?

**disneysteve** · 12-26-2007, 09:10 AM

Originally posted by atomicrc11 View Post

My Roth IRA is in Banc of America Investments with a Target Retirement 2040 fund. It is made up of funds from Columbia Investments. At this point, I don't want to manage my own portfolio, mainly because the sum is small, around 5k and that doesn't even meet the minimum for two funds at most brokerages.

What kind of expense ratio are you paying on that account? And are there any other fees or loads? I can't imagine their costs are as low as Vanguard. Vanguard's minimum is $3,000 so you have more than enough to switch.

Expense Ratios on Mutual Funds