Re-Gifted: Advantages of Low-Cost Mutual Funds
One of my first posts to this blog is one that I actually put to use today when I picked a mutual fund to throw some of my savings into. I decided to re-gift it for your enjoyment!
A common misconception about mutual funds is that pretty much any reputable fund will do. Of course, any investment that produces a solid return for you is better than nothing, but not all funds are created equal. When you buy a mutual fund, you’ll pay a management fee. It’s what you pay for someone to handle your accounts. A low-cost fund will charge you one-fifth of one percent per year. A typical high-cost fund will charge about eight times more than that.
Clark Howard recently quoted some research analyzing a 25 year old investing 10 percent of their $30,000 income each year until retirement into mutual funds. Comparing money put high-cost funds with that put into low-cost funds produced quite dramatic results. The good news is that the person investing in the high-cost funds ended up with around $1.7 million at retirement. Not too bad! But here’s the real kicker – the person investing in a low-cost fund ended up with $2.9 million!
What’s great about figures like these is that they show the amazing power of investing over time. Even better is that they show how simple decisions, like choosing a low-cost mutual fund over a high-cost one, can reap dramatic benefits. Look at it this way, would an extra $1.2 million (oh whatever the difference would be based on your age) be worth time it takes to make the right financial decision?
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January 29th, 2006 at 8:26 am
Howard’s pronouncement is right in general, but a hair misleading on the details. I’ll try to keep it brief here in your comments.
Assuming a $3,000 addition to the funds are made each year, it will take an 11% return to make $1.7 million in 40 years - and that 10.5% return is after fees.
Change the assumption, so our hypothetical person gets a 4% raise each year and continues contributing 10%, the total raises to $2.5 million. Not too shabby.
But I would take 11% with a huge grain of salt. Perhaps I’m too conservative, but my personal projections assume a max return of 8%. Make that change and our totals are $840,000 (no raise) and just under $1.4 million (with raise).
Hardly chicken feed, but it’salways worth looking into the figures. I’ll post this with an Excel file shortly on my site.
It is important to remember though that he is absolutley right with the general principles - save early and in a vehicle with low fees, ceteris paribus.
January 29th, 2006 at 5:56 pm
[...] I’ve attached a spreadsheet answering the “advanced” example from yesterday. In trhe meantime, I also came across a post over at Kirby on Finance that fits nicely into the topic at hand. [...]
January 29th, 2006 at 9:57 pm
I like doing future calculations also, but it’s pretty difficult for people to stay the course. In real life, people are always tempted to take money out of their retirement investments to buy cars, houses, or even useless stuff. I also like to keep expected returns at a conservative number.