In 2021 investors poured over $1 trillion into various mutual funds and ETFs. In light of the post-covid boom, it looks like investors raced to capture their fair share of stock market returns.
The fees that this has generated are being greatly enjoyed by the investment managers that oversee these funds. In this agreement, investors choose to forgo a portion of their market returns in the form of fees, often expressed as a percentage (expense ratio). In exchange for these fees, fund managers take the burden of making investment decisions for ordinary investors. However, an increasing number of investors are starting to question this arrangement;
How have these managers actually performed?
And
How much of this performance do I as the investor get to keep?
It is much like a question you’d ask yourself at the supermarket, “how much am I getting for what I’m paying?”. By looking at this group of fund investors, it is obvious to see who is getting the best deal.
People who invest in passively managed funds, such as one that tracks an index of the top 500 companies in the United States, do the best. Very little trading or stock buying is done by these types of managers, and as such, they charge much less.
On the other hand, actively managed funds are operated by managers who do make their own decisions as to what stocks to buy. Investors hold confidence in these managers to make more money than simply just an index, and they are paying higher fees for it. According to the Investment Company Institute3, the average expense ratio for an active mutual fund is 0.71%. Compare this to a passive Vanguard index fund where you are able to mirror the returns of the market for a mere 0.04%, almost 18 times cheaper!
So, what are you really getting in return for the extra “professionalism” fee charged by actively managed funds? Well, as it turns out, not very much.
Of course, you may be thinking “Don’t the years of expertise and knowledge of a professional fund manager make the mutual fund worth the extra percentage point?”. In theory you should have better returns, but according to John C. Bogle, founder and former CEO of Vanguard, during the past 25 years, while the index fund was providing an annual return of 9.20%, the “experts” running the actively managed fund was just averaging 8.21%2.
It looks like this “professionalism fee”, is not paying for itself after all.
This loss of a percentage point seems insignificant, until you run the numbers and find out just how devastating it can be. Let’s compare passive index funds and actively managed funds within the same time frame that Bogle discussed in his book. We will assume the investor holds onto an investment of $100,000 in both funds for the whole 25 years.
| Investment | 25 Year Avg. Rate | Minus Fees | Return |
| Index Fund | 9.20% | 0.04% | $894,516.13 |
| Actively Managed | 8.21%2 | 0.71% | $609,833.96 |
Nearly a third of your returns are wiped out! Lackluster performance and relatively high fees put investors at a significant disadvantage when investing in an actively managed fund. By investing in a low-cost index fund, you can keep as much of your money as you can without having to succumb to big fat fees. Smart investors will save themselves lots of money by simply avoiding high-fee mutual funds and instead investing in their better performing, lower cost counterpart, the index fund.
Notes
- https://www.morningstar.com/articles/1075161/us-fund-flows-smashed-records-in-2021
- Figure calculated by taking bogle’s 7.5% average net return that was adjusted for survivorship bias and adding back the average actively managed mutual fund fee supplied by the ICI. Bogle’s number is from the 2017 updated and revised Little Book of Common Sense Investing
- https://www.ici.org/doc-server/pdf%3Aper27-03.pdf
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