How to Invest: ETF and fund fees can take a big bite out of your returns

Everything counts in large amounts, and that’s particularly true of the fees investors in mutual funds and ETFs are charged.

It’s not always easy to conceptualize the impact of fees. Fees are usually small, and the impact of small numbers isn’t visible immediately. But they are when compounded over long periods of time.

Consider this: If an investor buys a fund indexed to the S&P 500 and pays 0.5% a year, after one year of return he or she probably has about 99.5% of the gain of the overall index. Not bad. What’s the big deal? Over 30 years, at 0.5% a year, the investor has captured less than 88% of the total gain of the index. 

Sure, over 30 years, you are likely to have a nice gain. But because of fees, 12% of your money is missing. Your gain could have been much bigger.

The money isn’t really missing, though. Mutual funds, after all, have expenses. They have people doing the research and handling all that paperwork to mail (or email) to fund holders, and those costs need to be covered.

Which means you need to be sure you get what you pay for. Why use an index fund that has a 2.4% expense ratio, when you could use, say, the Fidelity 500 Index mutual fund, which charges just 0.015%? The difference matters. Over 10 years, the cheaper fund would return 14.93% annualized, while the expensive one would return just 12.17%. Now that’s missing money.

Fees may be inevitable. Just try to keep them small. 

Before we get to the video, a question: How much should investors expect to pay each year in fees for the typical ETF or mutual fund?

Watch the video for the answer and more.