Investors who have stuck to underperforming, costly actively managed mutual funds should switch to low-cost index exchange traded funds, according to market maven Burton Malkiel.
“You can’t control what markets can do, but you can control the costs you pay,” Malkiel writes for the Wall Street Journal in an op-ed this week. “The less you pay to the purveyors of investment services, the more there will be for you. The quintessential low-cost investment vehicles are index funds, which should comprise the core of every investment portfolio. The high fees charged for active management cannot be justified.”
Malkiel is a professor of economics at Princeton University and serves as chief investment officer at Wealthfront. He worked as a director of the Vanguard Group and is a strong proponent of index fund investments.
The financial services sector has almost doubled in size in the past three decades and fees have been rising as a percentage of assets managed. However, investors have not seen a substantial increase in returns nor improved efficiency in the markets. [Cost Matters with ETFs: Vanguard Report]
“In my judgement, investors have received no benefit from this increase in expense ratios,” Malkiel writes. “The increase in fees likely represents a deadweight loss for investors.”
Malkiel argues that as the mutual fund industry expanded from less than $26 billion in assets under management since the 1980s to almost $3.5 trillion, the increase in economies of scale should have been passed on to investors, which would have lowered expense ratios – he even points out that expense ratios for actively managed funds actually rose to 0.91% in 2010 from 0.66% in 1980.
John Rekenthaler, V.P. of research for Morningstar, though, points out that the industry’s fee structure has changed. For instance, front-end sales changes have disappeared and replaced by 12b-1 fees. However, Rekenthaler acknowledges that low-fee investments have been drawing the lion’s share of new assets in recent years. [Index-Hugging Mutual Funds Shamed by Cheap S&P 500 ETFs]
“For some time periods circa 2000, there were more monies moving into funds with expense ratios exceeding 1.5% than into those with expense ratios of less than 0.5%,” Rekenthaler said. “Today, it’s the reverse, with institutional shares and exchange-traded funds accounting for effectively all of incoming assets.”
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article