Mutual funds: Know what you're paying for
January 02, 2014
When it comes to investing success, costs matter. The reason is simple: The less you pay for your mutual funds, the more you have available to invest and the more returns you get to keep.
"While you can't control many things about investing, you can control the costs you pay for your investments, which tend to be one of the greatest predictors of investing success," said Yan Zilbering, an investment analyst with the Vanguard Investment Strategy Group. "Investors are demanding lower-cost investment options and the industry as a whole is following."
The benefits of lower costs
You can't control the markets. But you can control what you pay to invest. And you may be surprised at how much difference that can make to your long-term success. Find out what mutual fund costs mean for your bottom line.
Vanguard is always striving to lower the cost of investing. For example, our average expense ratio in 2012 (the most recent year for which data is available) was 0.19%, nearly 83% less, on average, than the 1.11% industry average, according to data from Vanguard and Lipper, a Thomson Reuters Company. Over the past several decades, our average expense ratio has gone down more than 75%—from the 0.89% our investors paid in 1975 to 0.19% in 2012.
But what exactly are you paying for when you invest in mutual funds, and why?
Two types of expenses
In general, mutual funds have two types of fees: ongoing fund expenses, which are included in what's called the "expense ratio," and sales loads, which cover marketing and sales activities. Fund expenses are paid directly out of each fund's returns, so you might not realize how much of your investment balance goes to pay for them.
Costs covered by a fund's expense ratio
The expense ratio, which you see as a percentage of the fund's net assets, covers many of the costs that keep a mutual fund running, including:
- Investment management for the fund portfolio.
- Administrative and operating costs, such as personnel, office space, and equipment.
- Accounting and pricing for the fund, performed daily.
- Shareholder support services, including call centers, staff, and websites, and communications, such as statements, prospectuses, and annual and semiannual fund reports.
- Distribution support to get fund shares to investors, including activities with broker-dealers, banks, and retirement plan sponsors.
Costs covered by sales loads
Sales loads generally fall into three categories:
- Front-end load—a percentage charged when an investor purchases fund shares.
- Back-end load—a percentage charged when an investor redeems fund shares.
- Level load—a sales commission that's charged every year.
Vanguard funds are considered "no load," which means you won't pay front-end or back-end loads, or other sales commissions, or marketing or distribution fees, also known as 12b-1 fees.*
Why the expense ratio you pay matters
Because the expense ratio is paid directly from a fund's returns, it reduces your investment balance automatically. So when your expense ratio is lower, more of your dollars can remain invested.
Mr. Zilbering noted that savvy investors understand how the power of compounding—the snowball effect that happens when your earnings generate even more earnings—can help you grow your investments over time. "But when you pay more in expenses, you face a great headwind," he said. "You might not notice the cost of a higher-priced fund in the short term, but over time, the more expensive investments eat away at your portfolio's returns."
Costs matter, especially over time. If you invested $50,000 in a fund with the 2012 average Vanguard expense ratio of 0.19%, in 30 years you could have $65,793 more than someone who invested in a fund with the industry's average expense ratio of 1.11%. (This scenario is hypothetical; it doesn't refer to any specific investment. It assumes a 6% annual rate of return, with earnings being reinvested. There may be other material factors that must be considered before investing.)
Wondering how much you could potentially save with our lower average expense ratio compared with the industry average? Our fund savings calculator can show you, based on your investment amount and investing time period. You can change both the amount and investment period to get an idea of how saving more over a longer time may affect your savings.
Why you pay less with Vanguard
Our expense ratio is about one-fifth that of other fund firms.** One reason is because we can spread many fixed costs for administration, accounting, and shareholder support across our numerous mutual funds. This cost sharing helps reduce the share of expenses for each fund.
An even bigger reason? Because we can—and do—manage our funds at cost. That's thanks to our status as the only company in the industry that's client-owned—we don't have a third-party owner or management company. The clients who invest their dollars in our mutual funds are the owners of those funds. And those funds, in turn, own Vanguard.
The typical fund firm has external shareholders or private owners and, therefore, a fiduciary responsibility to share profits with those owners. Vanguard's client-owned structure means that we have a fiduciary responsibility to share profits with our investors. We use our profits to reduce fees for our client-owners and to improve how we serve them.
*Some funds are subject to a purchase fee or redemption fee.
**Vanguard average expense ratio 0.19%. industry average expense ratio 1.11%. Sources: Vanguard and Lipper, a Thomson Reuters Company, as of December 31, 2012.
- All investing is subject to risk, including the possible loss of the money you invest.
- Diversification does not ensure a profit or protect against a loss.