Investment fees matter - how to increase investment returns with low cost index funds

Are you interested in increasing your investment returns without any additional risk to your portfolio?  Of course you are!  But when was the last time you reviewed the investment fees you pay?

Investment fees matter more than you may think. Learn more about how to improve your investment returns immediately without additional risk.

Types of fees

  • Commissions – A fee charged by your broker when you buy or sell stocks, ETFs, or options. Recently most brokers have eliminated commissions.
  • Brokerage fees – A fee charged by the broker to manage and maintain your account.
  • 401(k) fees – A fee charged for the management of your 401(k) or similar retirement account.
  • Mutual fund load – A sales charge for buying a mutual fund. Charged at purchase (front-end load) or at sale (back-end load).
  • Management fee / Advisory fee – A fee paid to a financial advisor. Usually paid as a percentage of assets managed or a flat fee.
  • Expense ratio – A fee charged by mutual funds and ETFs for the management of the fund.

All investment fees will erode the growth of your investments, so it’s important to minimize the fees you pay. One of the easiest ways to save money on investment fees is to focus on selecting low cost funds when investing.

Each year billions of dollars are invested in funds (both mutual funds and ETFs) that charge high fees. Some funds will claim they provide superior value to investors and claim they can beat the market (although the historical data would show otherwise). Other funds simply charge higher fees than comparable funds with similar holdings.

What is an expense ratio?

Mutual funds and Exchange Traded Funds (ETFs) charge investors through an expense ratio which covers the costs of operating the fund. The number is expressed as a percentage of assets managed by the fund. When comparing expense ratios, lower is always better.

Expense ratios are published in fund prospectuses as well as a number of online financial websites resources for free. Here are a couple good sources:

  • ETFdb.com – source for ETF expense ratios
  • Morningstar.com – source for mutual fund expense ratios
  • Your brokerage account’s research area – I use Schwab.com

How much do investment fees cost? / impact of investment fees

Let’s look at an example of a fund with a very low expense ratio compared to one with a higher expense ratio.

The Invesco S&P 500 index mutual fund (SPICX) has an expense ratio of 1.31%.  By contrast, the most popular S&P 500 Index ETF, the SPDR SPY, has an expense ratio 14 times lower of 0.09%.  And yet, the Invesco fund has over $300M assets under management!  In aggregate, those investors could save about $4M in investment fees by switching to lower cost funds.

Both of these funds benchmark against the S&P 500 index so they hold essentially the same exact stocks. There may be some minor differences due to timing and re-balancing, but there is no material difference between their holdings.

Below are the results if you had invested $10,000 in each of these funds (which have the same holdings) over the past 10 years. Investing in the fund with the 0.09% expense ratio would result in $2,900 more at the end of the 10 years than investing in the fund with the 1.31% expense ratio.

Investment fees - impact over 10 years
An S&P 500 index fund with high fees erodes returns

Both funds hold the exact same investments so the higher fee fund will never outperform the lower fee fund. The investment expenses paid in fees erode the value of your investments because you lose out on their compounding effect.

Investment fees erode the value of your investments because you lose out on the power of compounding Click To Tweet

Investment fees erode long-term wealth

If the above example was not convincing enough, let’s also look at an example over 30 years. With a single $10,000 investment in a fund with no fees (for simplicity), your investment would grow to $100,000 after 30 years assuming an 8% annual return. That same investment in a fund with a 1% fee would grow to $76,000, almost $25,000 less than the no fee example. An investment in a fund with a 2% would be even worse, growing to $57,000 or $43,000 less than the no fee example.

Investment fees - impact over 30 years
Even small fees erode returns

Of course there are no funds available that do not charge any fees, but many get quite close (the lowest I’ve seen is around 0.03%). The lesson still applies: investment fees really matter because they erode your ability to grow wealth.

How to find low cost index funds

The solution is to find low cost index funds or simply look for low fees when investing in funds.

Actively managed funds generally have higher expense ratios than passively managed index funds. This is because actively managed funds require more investment research and management to build a portfolio. Index funds simply track benchmark indexes like the S&P 500 and the Dow Jones Industrial Average. However even index funds (with the same holdings as other index funds) can have drastically different expense ratios as we saw in the S&P 500 index fund example.

When comparing mutual funds and ETFs, generally ETFs have lower fees than mutual funds. However, some ETFs (especially some actively managed ETFs) can have high fees too. ETFs also provide better tax advantages to investors.

When looking for low cost investments, the best place to start is with ETF index funds. ETF screeners are available on many financial websites. I recommend ETFdb.com or your brokerage account’s resource area.

Because fees vary so widely it’s important to always check the expense ratios when evaluating a fund. And if two funds are generally comprised of the same investments (e.g., S&P 500 index funds), then you should always select the fund with the lower expense ratio.

How much should you pay in investment fees?

Many ETFs now have very low expense ratios below 0.1%.  If you’re investing in broad market stock or bond funds, especially ones that benchmark major indices like the S&P 500, then you should look for expense ratios below 0.1%.

Best low fee index funds

Here are some of my favorite low fee index ETFs across various asset classes. This list of ETFs across asset classed provides enough variety to build a diversified investment portfolio.

Asset classETFTickerExpense ratio
US equitiesSPDR® S&P 500 ETFSPY 0.09%
US equitiesVanguard S&P 500 ETF VOO 0.04%
US equitiesSchwab US Broad Market ETF SCHB 0.03%
International equitiesSPDR® Portfolio Developed World ex-US ETF SPDW 0.04%
International equitiesSPDR® Portfolio Emerging Markets ETF SPEM 0.11%
Fixed income (US bonds) Schwab U.S. Aggregate Bond ETF SCHZ 0.04%
Fixed income (intl bonds) iShares Core International Aggregate Bond ETF IAGG 0.09%
Real assets – cash equivalents Schwab U.S. TIPS ETF SCHP 0.05%
Real assets – REITs Schwab U.S. REIT ETF SCHH 0.07%
Low fee ETFs by asset classes

401k account expense fees

401k and similar retirement accounts are notorious for having a limited selection of funds with sometimes exorbitantly high fees.  When choosing between investments in these accounts, expense ratios should certainly be a consideration for your investments.

Even though accounts typically have limited options (e.g., between 10 – 20 total funds), many times there will be 2-3 funds for each asset class.  So for example, if you are using the 60/40 portfolio (60% stocks, 40% bonds), you might have 2-3 different fund options for the equities (stocks) asset class.  Although they may be slightly different with different benchmarks (e.g., S&P 500 vs the Russell 2000 indices), you may be better off by just selecting the fund with the lower expense ratio due to the wide range of fees.

Taking action

Do you know how much you are paying in investment fees? If not, start by checking the expense ratios of your current investments.

This includes all of your accounts, including IRAs, brokerage accounts, and 401k or similar employer retirement accounts.  If your fees are higher than 0.1% you should look into some lower cost options and put some money back in your pocket.

To summarize:

  1. Check your investment expense ratios (IRAs, brokerage accounts, 401k retirement accounts)
  2. If any fees are higher than 0.1%, look for lower cost funds (use my list above)
  3. Check the expense ratios of the funds in your 401k or similar retirement account
  4. Within your retirement plan options, look for similar lower fee funds

How much are your investment’s expense ratios? What are your favorite low fee funds? Let me know in the comments!


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Investment fees matter: How to increase investment returns with low cost index funds

4 thoughts on “Investment fees matter: How to increase investment returns with low cost index funds

  • July 17, 2020 at 8:00 pm
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    Invaluable information, especially when comparing like-for-like products (eg: an index fund tracking the same index). Why pay more for the same product only to get a lesser return?

    Reply
  • July 22, 2020 at 8:29 pm
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    Minimizing fees is definitely one of the best strategies you can execute in order to increase long term gains. Doesn’t take a lot of time to find the best funds

    Reply
  • July 22, 2020 at 8:58 pm
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    Very informative, AI. I was helping my son-in-law with his company’s RRSP ( traditional 401k equivalent in Canada). The company was charging him more than 2% on the money market option and 2.3%-2.5% for the fund options. The return on the money market was negative because the employees paid the fees instead of the employer.

    He was considering maxing out his contributions. My advice was to put in the maximum amount that would be matched by his employer and put the rest in an individual RRSP or TFSA (Canadian equivalents to Traditional and Roth IRAs).

    Reply
  • August 10, 2020 at 9:48 am
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    I’m just getting started with investing in dividends, so I have a long way to go. It is very valuable that you share your experience.

    Reply

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