Cut Management Fees to Increase Return
Mutual funds are a great way to invest your money in the stock market, but all mutual funds charge a management fee. Actively managed funds carry a fee, on average, of approximately 1.5%. That means you pay 1.5% of your total account balance per year for the fund to manage your investments. While that may not sound like much, consider the difference of just 1% in annual charges on a $100,000 investment over 30 years. Assuming a 6.5% annualized return, a $100,000 initial investment will grow to $498,400 with a 1% annual fee. When a 2% fee is charged, the investment will only grow to $374,500, a difference of more than $120,000!
Alternatively, you can achieve the same access to the stock market and the same diversification of mutual funds with equity index funds, and they charge less than .5% in annual fees. The reason is that equity index funds are passively managed, meaning, they invest in a portfolio of stocks that replicate a stock index, such as the S&P 500, and they rarely buy or sell stocks.
Yes, but how does their performance compare with mutual funds? Interestingly, passively managed funds outperform most actively managed mutual funds by a margin of more than 50 percent in any given year. Active fund manager very rarely “beat” the market, and when they do, they rarely repeat that performance. So, the big question is “Why should you pay 1% to 2% to an active fund manager, when you can do at least as well with a passive fund?”