Watch Those Fees to Improve The Performance of Your Portfolio

Everybody is looking for a way to squeeze a little more return out of their investments. Some will take the next step up the risk ladder while others will look at tax-advantaged accounts as a means of keeping a little more in their pockets. Both of these are certainly reasonable methods of improving your investment return, but one of the more often overlooked methods of increasing your return is the one you have the most control over – reducing portfolio expenses.

The difference in expense ratios between substantially similar investments can be significant too. Consider a generic S&P 500 index mutual fund. Index funds should carry low expense ratios to begin with since they’re simply mimicking an index and not actively managing the portfolio. Vanguard has always been a low cost leader in the mutual fund world. Their Index 500 Fund currently charges 0.18%. Fidelity offers a similar fund at even a lower rate of 0.10%.

While most fund companies are reasonable in their index fund’s expense level, some are downright excessive in how much they charge. For example, State Farm levies an abnormally high 1.50% on the B class of their S&P 500 index fund shares. Rydex, however, takes the cake charging an atrocious 2.28% on their fund’s C class shares. Invest in one of these funds and you’ll automatically lag 1.5% to 2.0% in fund performance every year in comparison to one of the low cost alternatives.

So how does the fund’s expense ratio affect your portfolio’s performance? Let’s put this into actual numbers.

Imagine you were to invest $10,000 into two of the mutual funds mentioned above – the Vanguard Index 500 fund and the Rydex S&P 500 fund – and assume that both funds were to average an 8% annual return for 10 years prior to expenses.

With the Vanguard fund and its 0.18% expense ratio, you would end up with $21,232. Fund expenses would have ended up costing you a total return of just $357 over the course of the 10 years.

Investing in the Rydex fund and its 2.28% expense ratio, you’d be looking at an ending value of just $17,441. The exorbitant expense ratio on this fund would have cost you a total of $4,148 over the life of the investment.

That’s a huge difference in after-expense return for investing in essentially the same thing. Vanguard ended up retaining just a little over 2% of the total return of the fund in our example. Rydex on the other hand would have kept over 28%.

You can start to see why watching your fund’s expense ratio is important. It can end up costing you thousands of dollars or more over a relatively short period of time. If you have even more to invest or you plan on leaving your money invested in the fund for a period longer than 10 years, the difference grows even larger.

So how can you make sure you’re targeting only those funds with a minimal expense ratio? Check out Morningstar’s Fund Selector tool. You’ll be able to filter on a number of categories like fund category, returns, expenses, turnover and ratings. It’s a great tool that can help keep you on target with the most important of all your financial goals.

Keeping more of your money in your own pocket.

Photo credit: turtlephotography