By Gary Brooks, CFP®
Theoretically, before making an investment in a mutual fund or exchange-traded fund, every investor – whether acting on their own, through an advisor or within an employer retirement plan – has access to information that shows the cost of the investment.
What is missing in many cases is easy-to-retrieve information about comparative products. And many people fail to perform comparative due diligence. How else to explain that some people invest in products that cost many multiples of nearly identical products from other providers?
Differences in cost between actively managed funds where a professional money manager is making investment choices is understood. Each manager applies a different process, has staff to pay, administrative costs, and so on. The amount of money they manage also dictates what the fee is. And we know that this form of active management costs more than passive index funds that are unmanaged.
But if we’re comparing basic index funds, how can one company get away with charging an obscene premium compared to another?
For instance, let’s examine funds that replicate the S&P 500 index of large U.S. stocks.
An investor could buy the Vanguard 500 Index with fund-level expenses of 0.05% of assets (Admiral Share class – VFIAX) and no sales charge. The minimum is $10,000. Investors without $10,000 to invest can buy a different share class with a 0.17% ongoing management fee.
But many investors aren’t aware of their options. They are steered to a particular mutual fund company for some reason and they get hosed.
Consider these five comparisons.
- The MassMutual S&P 500 Index (MMFFX) Class A share has a management fee of 0.72% (Vanguard is 93% less). And that is without including the 5.75% upfront sales charge to pay the MassMutual representative for selling this fund. Amazingly, this fund has $3.6 billion under management (including other share classes with lower expenses, but still not as low as is available elsewhere.)
- The State Farm S&P 500 Index (SNPAX) has $1.1 billion. Its Class A share charges even more – 0.74%, but has a smaller sales load (5.0%).
- The Mainstay S&P 500 Index (MSXAX) charges 0.60% with a 3% upfront sales commission. It has $2.1 billion across share classes. (Mainstay is the mutual fund family of New York Life Insurance.)
- The Nationwide S&P 500 Index (GRMAX) charges 0.57% with a 5.75% upfront commission and $2.7 billion under management.
- The Dreyfus S&P 500 Index (PEOPX) charges 0.50% on $2.9 billion without any sales charge.
Unfortunately, there are other high-expense index funds – and I didn’t chose those that were the most expensive or had the most assets. I just selected five.
Investors in these funds collectively pay dozens of millions of dollars in extra expenses without any extra investment return compared to the Vanguard products or a similar exchange-traded fund like Schwab Large Cap (SCHX, 0.04% management fee).
You may have picked up on a theme here that investment products from insurance companies are significant culprits. To be fair, some of these companies offer less expensive share classes with higher investment minimums and different compensation arrangements if an advisor is involved in the sale of the product.
The average American who is not a sophisticated investor or is limited to the choices in their employer’s retirement plan is too frequently paying way too much for a core piece of their savings.
If you are an employer retirement plan participant and find that your fund choices are meaningfully more expensive than similar alternative products, ask your human resources rep or retirement plan administrator to re-evaluate the fund choices and offer less expensive options.
If you have been funding an IRA with your insurance agent because it seemed convenient to have your investments in the same place as your life or home insurance, think seriously about other alternatives. You may have an excellent insurance agent who deserves the commission on the investment product but the ongoing management expenses of the fund may be way more than you expect.
If the material you receive from fund companies, a broker, or your company plan aren’t clear about expenses – research your fund choices at Morningstar.com (which is where the expense and fund assets information for this article were obtained.)
As they say on the NBC public service announcements … the more you know.
~ BHJ Wealth Advisors — Gig Harbor, Washington — 253-534-8888