A key advantage to exchange traded funds (ETFs) is their ultra-low expense ratios (on average) compared to the expense ratios of mutual funds. Although the expense ratio is only one factor to consider, studies show that over long periods of time, it can save or cost you vast sums of money.
A recent study done by MarketRiders digs down and gives us a look at how high fees hurt you over long time periods and the results should stun anyone trying to save for retirement.
MarketRiders CEO Mitch Tuchman created two portfolios: each started with $100,000, assumed a $4,000 annual contribution, an average expense ratio of 0.21% for the ETF portfolio and a 1.39% expense ratio for the mutual fund portfolio and an annual 7.5% return. The portfolios were composed of plain vanilla funds held in a non-taxable account. [ETFs in 401(k) Plans: What Your Should Know.]
What happened? Well, we’ll let the numbers do the talking:
If an investor opened each account at age 35, by age 76 his mutual fund portfolio would be worth $2.04 million while his ETF portfolio would be worth a considerably larger $3.15 million.
Whoa.
Granted, the situation is highly theoretical since it is unrealistic to assume that both portfolios would perform identically. But the example shows the strength of compounding interest, even with small percentage differences, over a long period of time. [10 Reasons to Love ETFs.]
“People are scrounging to put away $4,000 a year, and half of it is getting sucked away in fees,” Tuchman says.