Take-aways
- Return % is important but you need more info to make the best investment choice.
- Expense ratio appears to be the most important factor next to return %.
The Problem
Over the years, I’ve acquired a few 401k accounts including one with Fidelity, Vanguard and USAA. I have always taken an interest in investing. There is certainly no shortage of advice out there and it is perhaps a bit challenging to learn the tricks of the trade within the confines of a 401k account.
You might think that it’s simple… just look at the short-term and long-term returns of a fund, right? Pick the one that has the highest returns. You might even think that you could just look at the Morning Star ratings of your available mutual funds and pick the one with the best rating. You might be fooled though…
The finance industry has found many ways to make as much money as possible from their clients – not the least of which is by creating confusion. How do you pick out the most important facts about a fund when there are pages of dollar signs and percentages to sift through? Below, I will provide a simple way to pick the funds that will likely give you the greatest return.
The Solution
Recently I read “MONEY Master the Game” by Tony Robbins and currently I’m reading his new book, “Unshakeable“. In both of them, he illustrates how mutual fund fees are a long-term killer of returns. Interested in improving my own returns, I did a study of all of the available funds in my 401k accounts. The results were somewhat surprising to me so I’ll illustrate just one example using a fund from my Vanguard account, one from my Fidelity account and investing a hypothetical $10,000.
| Starting Portfolio Value | $10,000.00 | Difference | |
| Investment | Fund 1 | Fund 2 | |
| Average Annual Return | 7% | 7% | 0.000% |
| Expense Ratio (fees) | 0.10% | 1.075% | 0.975% |
| Effective yearly return (after first year) |
6.9% | 5.93% | 0.975% |
What does this mean to me?
In the example above both funds reported an average return of 7%. What this actually means is that Fund 1 had to make 7.1% in order to pay you 7%. Likewise, Fund 2 had to make 8.075% in order to pay you 7%. That’s a difference of almost 1% extra that the fund has to make in order to keep up! Compound the expense difference over 30 years and let’s see what you get…
| Investment | Fund 1 | Fund 2 | Difference |
| Portfolio Value After 30 Years | $74,016.95 | $56,228.20 | $17,788.75 or 31.64% |
I Do Conclude
So… after 30 years you could have made an extra 31% on your money just by paying attention to what might seem like a small difference in the fund expense ratio (fees).
Returns = Gains – Expenses
For more mind-blowing info, I highly recommend Tony’s books as well as this write-up from Vanguard.
Do you use any other (potentially better) techniques to select funds? I’d love to hear from you! Leave a comment below!
P.S. Watch for my next post which will include a tool for running these calculations for yourself!