Financial Tip Friday: Watch Out for Mutual Fund Fees

Financial Tip Friday: Watch Out for Mutual Fund Fees

Over the past 90 years and even going back further than that the stock market has gained an average of about 11.5% per year, depending on what date you start at. Of course this is not a straight projection. We have years when the market goes down by 30% and some when it goes up by more, but on average it is about 11%. You could argue that we have been in a golden age of stock growth for that time period.

However, many analysts believe that in the future we will only have gains of about 7%. Now 7% is still a helluva lot better than putting it under your mattress or in a savings bond, but it is certainly less than that 11% and over a 30 year time period that can mean a huge difference like hundreds, if not millions of dollars, difference.

I think 7% is a good baseline figure. I personally think trying to project 30 years out is a bit on the weird side and I do believe returns will be higher. But to be on the safe side let’s work with 7%. If that is the case than that 7% has to do a lot more work than the old 11% return.

In other words, when you reach retirement you want to have enough money to live off, but not necessarily run out of it. Wealthfront, an online brokerage service, does a good job of providing examples of how much fees can cost you.

There are all kinds of rules of thumb  for withdrawing that money. The classic rule is the 4% rule. If you withdraw 4% of your money for the rest of your life that money should last you as long as you live and have some left over.

The problem with the 4% rule is that it sometimes depends on when you retire, where you retire, and sticking to 4% a year no matter what can be hard for some people, particularly if tragedy strikes. So in a perfect world the 4% rule is a good rule of thumb.

And if you think about it can work. I mean 4% out of a 7% return you should never have to trust your principle.

One of the problems with that mentality is in the accumulation phases of your future retirement plans. 7% is great, but the people who are managing that money expect to get PAID! The money they are paid are from fees from your mutual funds. In an industry study in 2013, the average mutual fund fee is 1.25%. So if we take that 1.25% we then shave it OFF of your 7% return and now your return is more like only 6%. 6% is much closer to 4%.

High cost mutual fund fees can cost an investor tens of thousands, if not hundreds of thousands of dollars over the course of their saving lifetime. That is why I am an advocate of index funds. Index funds have extremely low fund costs. The average index fund is about .25% That is a full percentage point lower than the normal mutual fund.

NerdWallet has a great primer on fees. Here is also another great primer.

1% doesn’t sound like a lot, but if you add it up over years it can cost you tens of thousands of dollars, particularly considering if you invest consistently you probably have a few hundred thousand, if not millions of dollars in the bank when you want to call it quits in the workplace.

The Bottom Line: I am not advocating that you go out and sell all of your mutual funds right away. However, you should take a look at how much they are charging you for your expense ratios. I do have one mutual fund that charges me .6% per year, much higher than the .2% that I like (again it adds up over time). I am not ditching that fund because of its performance. But you should do your own due diligence and research to see what your fund fees are. And if you find they are too high for your liking then perhaps there is another investment that is similar with lower fees. It is amazing how much redundancy there is across the mutual fund world.

Remember, do you research. You can find all of those fees by doing a simple Google search.

Leave a Reply