The Expense Ratio Game
If you are a regular reader of these blogs, you’ll notice ongoing references to costs. Costs are important because they directly lower returns. With this in mind, I’d like to share an interesting investment industry tactic that confuses investors.
Mutual funds dominate the investment world. They offer diversification and are easy to buy, sell, and own. Every mutual fund has costs detailed near the front of their prospectus. Too often, the same fund offers multiple variations with widely different costs.
I reviewed American Funds Growth Fund of America—one of the largest and most touted mutual fund. It is generally a “loaded” fund—investors pay brokers a commission to buy it
According to Morningstar, you can buy this same mutual fund 15 different ways (including 5 separate versions for college 529 plans). Why so many versions? To answer you need to realize that the underlying expense ratios range from 0.37% (cheapest) to 1.5% (most expensive). You buy the same thing at a different cost.
Why the difference? It depends who is selling the fund and how they are paid. Amazingly there is more than 1% difference between the cheapest and most expensive version. That’s > 1% per year directly lowers returns.
By the way, even no-loads play this game. Fidelity offers load and no-load funds. Their Equity Income fund has 9 different “classes” with expenses ranging from 0.53 – 1.80%.
The lesson: mutual funds are a great way to invest but realize the fund industry packages their product in multiple formats. Do your homework. Don’t ever buy an expensive version since the low cost versions always deliver better results.