If you compare the performance of high-cost, actively-managed funds to that of a low-cost index bond fund, chances are you’ll find that the extra money you’re paying isn’t buying you a track record that would justify the added cost.
When an actively managed fund is chalking up big gains, the fact that it charges three or four times as much as a similar low-cost index fund doesn’t seem to make a lot of difference. Surprisingly, the same psychology kicks in when losses go into double digits. How much worse is a 20% loss than an 18.5% loss? It’s when gains and losses get razor thin that the difference between a costly fund and a cheapskate one stands out.
Take the recent rush into bond funds. Of the more than $200 billion investors have shoveled into bond funds so far this year, the bulk is going into actively managed funds, which charge an average of 1.03% to invest your money, according to Morningstar, the mutual fund research firm. Some charge almost 3% of your assets. With 10-year Treasuries in the 3% to 4% range, those fees of funds that are primarily invested in federal government securities are taking a big bite out of any gains. Skinflint index funds, which charge as little as 0.22% of assets, are a better choice, say many investment advisors.
If 1% versus 0.22% doesn’t sound like a big difference, those same investment advisors suggest that you do the math. Multiply the assets in your bond fund by the fund’s expense ratio to come up with a dollar amount. How would you feel if you had to write a check for that amount once a year? Then compare that number with the amount you’d pay to a low-cost index bond fund. If you also compare the funds’ performance, chances are you’ll find that the extra money you’re paying isn’t buying you a track record that would justify the added cost.