There are some advisors and (loud) financial voices out there who are still promoting the use of mutual funds in your investment portfolio...
We’re going to break down and explore just how expensive they really are and the impact mutual fund and exchange-traded fund fees have on your portfolio’s long-term performance...
More...
In our last post, we explored the significant impact advisory fees can have on your bottom-line.
It was pretty alarming, right?!
Where, just due to an industry-average advisory fee of just 1%, after 30 years your account was only 44% your initial projections.
Now, let’s take this honest exploration (that we’ve been undergoing over these last couple of weeks) of actual returns that you can realize in the market one step further...
FUND FEES
Think about where these broker-dealers and RIAs (registered investment advisory firms) are ultimately investing.
Most will invest in mutual funds and exchange-traded funds (ETFs)—both of which bring with them yet another layer of fees (the former much more significant than the latter).
Even when your firm invests some of your money in individual stocks (thus, not incurring a fund’s fees), they tend to find a way to hurt your bottom line regardless—Edward Jones, for example, will charge you a ~2% commission and Northwestern Mutual just has a flat (and relatively high) trading commission that is automatically pulled from your account every time your rep puts you in or out of an individual stock position (which is even more destructive on smaller accounts).
But, back to the funds… Let's start with Mutual Funds.
Mutual Funds
Mutual funds are investment programs where investors are essentially pooling their money in order to allow a money manager to diversify their holdings.
Vanguard, BlackRock, Fidelity, and American Funds are by far the largest mutual fund families in the world—each boasting more than $1.5T in assets.
While BlackRock is contending with Vanguard on the ‘low fees’ front (don’t worry, they’ll come up again later), Fidelity and American Funds continue to rock some pretty hefty charges.
Northwestern Mutual’s go-to fund provider is the old-guard behemoth, American Funds. Part of the reason for this is because with these higher fees that they're extracting from investors, American Funds is able to offer a larger cut to middlemen—e.g. Northwestern corporate and the individual agents (their ...sales reps).
However, with Vanguard, for example, and its lower fees there isn’t as much to share. Thus, during my Northwestern tenure, I became very familiar with the American Funds fee structure.
Share Classes
Advisor-sold mutual funds often have different options for how you’d like to structure their fees. These different options are called share classes.
- A Shares will charge a large front-load fee. And then, they have lower on-going fees: for marketing and operating expenses.
- B Shares (not very common) charge a back-end load and come with higher on-going expenses.
- C Shares are considered to have a “level” load—there’s no front-end charge, they (generally) have a much lower back-end fee, and their operating expenses are relatively higher.
A and C shares tend to be the most common among retail investors (that’s the industry term for the non-professional investor). Let’s start by exploring the latter with its level annual fees.
Quick note: If doing this digging yourself, use caution to look for the total net annual expense ratios and not just the management fees. The total expense ratio is always larger than the management fee alone (even if that difference is, for some funds, negligible).
American Funds’ largest fund is the Growth Fund of America (AGTHX) with $115B in assets. The net annual expense ratio for C Shares is 1.4%. (source)
Obviously, another 1.4% hit to our sum (from our last post) would be significantly impactful—as it would be for your long-term returns, if that’s how you’re invested.
There are some advisors (even some I know personally) who will simply plug you into a portfolio of American Funds funds and charge you their own (significant) advisory fee on top...
A 1% advisory fee + a 1.4% fund fee is crazy destructive to your bottom line!
But, to be fair, most don’t do that.
...most!
Most of the advisors with those larger firms utilize a mix of mutual and exchange-traded funds.
Exchange-Traded Funds (ETFs)
An ETF is a security derived from a collection of stocks (usually) that often track an underlying index (e.g. S&P 500, DJIA).
Because the funds’ underlying holdings are based on whatever its respective index is doing rather than rigor