The Big Secret of Stock Investing: Fees Matter

Now that you know the stock basics, you’re ready for perhaps the most important information in this chapter: fees matter. There’s nothing magical about index funds. If the index they track goes up, the fund goes up with it, and you make money. If the index goes down, the fund goes down, and you lose money. Actively-managed funds tend to be a lot more expensive than index funds, and these added costs take a bite out of the money that these funds can make for you. Every mutual fund company charges its investors an annual fee in order to cover its costs, pay its managers and other employees, and make a profit. This fee, called the expense ratio, varies widely from fund to fund, but is always a percentage of the money you have in a particular fund. For example, if you have $1,000 invested in a fund that carries an expense ratio of 1.83 percent, the fund company will automatically deduct $18.30 from your account. In late 2006, the average actively-managed stock mutual fund carried an expense ratio of 1.49 percent, or $14.90 on every $1,000 you invest. On the other hand, you can find index funds that charge as little as 0.07 percent, or 70 cents on every $1,000. While performance will vary from fund to fund and from year to year, this fee gap means that, everything else being equal, your actively-managed fund has to beat the index fund by an extra 1.42 percent every year just to break even. Over the long haul, there aren’t too many active managers who can do that. If you invested $1,000 in an index fund and your friend invested the same amount in an activelymanaged fund—both returning the same eight percent per year—after 10 years, you’d have $266 more than your friend because the average managed fund costs so much more than the index fund. Go back to 20 years ago, and you’d be ahead by $1,071 today. Whether you choose an index fund or an actively-managed fund, focus on lower fees. Many mutual fund companies also make investors pay an added fee called a load. There are several types of loads, but they all boil down to a sales charge or commission—again, a percentage of your investment—that you pay either to buy into a fund or sell your shares. There’s no evidence that funds that charge a load do any better over the long run than those that don’t, so you should definitely avoid the added fees whenever you can. There are over 2,000 noload funds to choose from.