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.
He likens the mutual fund industry today to what the tobacco industry was in the 1940’s. “They made you believe that smoking is healthy, but it’s really a slow, insidious process of killing people. We’re really trying to get people to open their eyes to this and put the numbers in their face.” [ETF Portfolio-Building Basics.]
Investors have the power to protest high fees by voting with their feet, he says, by taking their money out of mutual funds and managing their own low-cost ETF portfolios. “It’s gotten really easy to do it; [not long ago]you couldn’t manage your own globally diversified portfolio, but today you can.”
It’s only fair to note that not all ETFs are cheaper than all mutual funds. Whatever your investment of choice may be, this study underscores the importance of paying attention to expense ratios and understanding how seemingly tiny amounts of money add up to big bucks in the long run. It’s imperative to always understand what you’re paying and take any necessary steps to slash costs when you can. [ETFs vs. Index Funds.]
It’s also worth noting that if you’re a buy-and-hold investor, you’re going to lose money in bear markets whether you’re holding ETFs or mutual funds. [Why Buy-and-Hold is Dead.]
Small amounts really do add up.
Read MarketRiders’ full study here.
For more stories about ETFs, visit our ETF 101 category.
Sumin Kim contributed to this article.