Fund Fees Can Be a Crucial Investment Factor

Reading a mutual fund prospectus may make your eyes glaze over, but it helps if you know what to look for. In the opinion of many fund experts, the most critical piece of information you'll find in the prospectus is the fund's expense ratio. Too many physician-investors focus instead on past performance, which can be misleading, while ignoring the fact that high fund expenses can blow a big hole in the most carefully planned portfolioâ€"an effect that can be intensified by a bear market.

Reading a mutual fund prospectus may make your eyes glaze over, but it helps if you know what to look for. In the opinion of many fund experts, the most critical piece of information you’ll find in the prospectus is the fund’s expense ratio. Too many physician-investors focus instead on past performance, which can be misleading, while ignoring the fact that high fund expenses can blow a big hole in the most carefully planned portfolio—an effect that can be intensified by a bear market.

Take a look at the math. The average expense ratio for an actively managed stock mutual fund is 1.40%. The expense ratio for a stock index fund can go as low as 0.18%, or even lower. Over time, the fund with lower expenses will deliver a much fatter nest egg, assuming the return on both funds are the same. In 20 years, $100,000 invested in the low-cost fund, assuming an average annual gain of 10%, will deliver a retirement stash of $640,490. The assets in the actively managed fund, on the other hand, will add up to just $510,270.

Add a load to a fund’s fees, and the results get even worse. A load is simply a sales charge tacked on to the cost of the fund and can range as high as 8.5%, but usually averages about 5%. Based on the same criteria in the above example, a fund with a 5% load and a 1.40% expense ratio will have just $410,270 in it after 20 years. The bottom line: choosing a high-expense load fund over a low-cost index fund can eat up almost 36% of your profit over 20 years.