4 ms·

Study finds that low fees are best indicator of mutual fund performance

35 points by ryanwaggoner 16y ago

bolu 16y ago
Makes sense, though it's probably a correlation to the root source of outperformance, which is being an index fund. Cheaper funds tend to be index funds, index funds tend to outperform, thus cheaper funds end up outperforming more expensive (usually more actively managed) funds. One of the seminal studies on this is http://www.firstquadrant.com/downloads/How_Well_Have_Taxable.pdf http://www.firstquadrant.com/downloads/How_Well_Have_Taxable... What's more, the more expensive (again usually actively managed) funds tend to have high turnover, and turnover implies a huge tax penalty for taxable investors in taxable accounts. So if anything, the winnings of lower-fee index funds are understated, as turnover-generated tax hits are not disclosed well. I agree with the author completely - hopefully more disclosure, legislated, would entice more people to shop for lower-fee funds. (Full disclosure, I run a startup that's based on helping people do index investing, so I might be biased ;p)
- davidw 16y ago
  So what do you think of ETF's? From what little I've read, that seems like a pretty good way of doing index investing.
  - bolu 16y ago
    They're good - gotta watch out for your effective expense ratio, which is the amount of commission you pay for the trade (depends on your brokerage house and the ETF) divided by the years you plan to own it, added to the ETF's own existing expense ratio. So net net, buy in larger chunks, or find one of the no-commission-ETF houses. Also, and it sounds like you are, you need to be familiar / comfortable with limit orders or market orders. That sometimes can scare folks who are used to not-very-time-sensitive daily-priced mutual funds.
    - davidw 16y ago
      Actually I don't know much at all about investing. I know what a stop loss order is, but I don't think I'd know how to use one effectively.
      - bolu 16y ago
        You probably won't need it, unless you're doing something significantly more complex than the fundamental buy-and-hold index investing strategy. I'd just use market orders all the time except I'm a little freaked out about momentary (on the order of minutes) market freak-outs as happened a couple months ago. Limit orders priced at the current price (or 1 cent higher) is pretty much just my way of enforcing a sane market order.
      - mcknz 16y ago
        Stop limit orders are a good way to determine when to sell, which is the toughest decision to make. Even if you are dollar cost averaging into a position, you can set a limit order to protect profits, or prevent a large loss. I've seen some recommendations to put a stop limit order of a certain percentage on any new position for stocks/ETFs as a way to keep emotion out of your decision. A trailing stop limit order allows you to sell only when a stock/ETF goes down.
  - mhb 16y ago
    You should probably read this: http://www.businessweek.com/magazine/content/10_31/b4189050970461.htm http://www.businessweek.com/magazine/content/10_31/b41890509... It's about commodity ETFs so maybe index fund or other ETFs don't have the same problem, but the message I got out of it is that there are plenty of unknown unknowns here.
    - davidw 16y ago
      > "I make a living off the dumb money," says Emil van Essen, founder of an eponymous commodity trading company in Chicago. Van Essen developed software that predicts and profits from pre-rolling. "These index funds get eaten alive by people like me," he says. Yeah, that sort of thing is what scares me about investing. I don't want to do it full-time, but it looks like there are tons of smart people out there who do make it their job, and are out to get you.
patio11 16y ago
Bogleheads have known this for thirty years now. Buy index funds, people. Defaulting to Fidelity & etc 2 percent fee funds, like many do in their 401ks, will cost you literally millions over your lifetime.
- bolu 16y ago
  Sigh... so true. I only wish the economics were different. If, like Fidelity, you extract a ton in fees it allows you to swamp the airwaves with marketing dollars. And the folks who just keep their heads down and do their jobs, well, don't have as much money to run ads. And in this market, unfortunately, because few people understand it deeply ad dollars can move the needle. Unfortunate, to say the least. This is not even considering the who commissioned-advisor problem.
  - patio11 16y ago
    On the Predictably Irrational blog there was an example of how clients recommended Fidelity and Vanguard evenly picked Fidelity on the basis of 25k bonus airline miles (cash value $250) so that they could pay $2~20k extra a year in management fees. I wanted to cry... And figure out how to offer airline miles.
    - bolu 16y ago
      It's because the fees charged don't appear as a line item on your statement. It's probably the only thing most American families spend more than a $1000 a year on (I did the math), for which they get no documentation... not even a receipt. Can you imagine how different the world would be (and how much less Fidelity would make) if you had to pay fees out of pocket? A single piece of simple legislation that disallows silently deducting fees from your assets would be all it takes. My co-founder and I sometimes sit at dinner thinking that if we do nothing else for the world but make fees (both expense ratio and more subtle ones like turnover-induced tax hit) more tangible, then we'll have succeeded.
      - InclinedPlane 16y ago

35 points by ryanwaggoner 16y ago

bolu 16y ago

Makes sense, though it's probably a correlation to the root source of outperformance, which is being an index fund. Cheaper funds tend to be index funds, index funds tend to outperform, thus cheaper funds end up outperforming more expensive (usually more actively managed) funds. One of the seminal studies on this is http://www.firstquadrant.com/downloads/How_Well_Have_Taxable.pdf http://www.firstquadrant.com/downloads/How_Well_Have_Taxable... What's more, the more expensive (again usually actively managed) funds tend to have high turnover, and turnover implies a huge tax penalty for taxable investors in taxable accounts. So if anything, the winnings of lower-fee index funds are understated, as turnover-generated tax hits are not disclosed well. I agree with the author completely - hopefully more disclosure, legislated, would entice more people to shop for lower-fee funds. (Full disclosure, I run a startup that's based on helping people do index investing, so I might be biased ;p)

davidw 16y ago
So what do you think of ETF's? From what little I've read, that seems like a pretty good way of doing index investing.
- bolu 16y ago
  They're good - gotta watch out for your effective expense ratio, which is the amount of commission you pay for the trade (depends on your brokerage house and the ETF) divided by the years you plan to own it, added to the ETF's own existing expense ratio. So net net, buy in larger chunks, or find one of the no-commission-ETF houses. Also, and it sounds like you are, you need to be familiar / comfortable with limit orders or market orders. That sometimes can scare folks who are used to not-very-time-sensitive daily-priced mutual funds.
  - davidw 16y ago
    Actually I don't know much at all about investing. I know what a stop loss order is, but I don't think I'd know how to use one effectively.
    - bolu 16y ago
      You probably won't need it, unless you're doing something significantly more complex than the fundamental buy-and-hold index investing strategy. I'd just use market orders all the time except I'm a little freaked out about momentary (on the order of minutes) market freak-outs as happened a couple months ago. Limit orders priced at the current price (or 1 cent higher) is pretty much just my way of enforcing a sane market order.
    - mcknz 16y ago
      Stop limit orders are a good way to determine when to sell, which is the toughest decision to make. Even if you are dollar cost averaging into a position, you can set a limit order to protect profits, or prevent a large loss. I've seen some recommendations to put a stop limit order of a certain percentage on any new position for stocks/ETFs as a way to keep emotion out of your decision. A trailing stop limit order allows you to sell only when a stock/ETF goes down.
- mhb 16y ago
  You should probably read this: http://www.businessweek.com/magazine/content/10_31/b4189050970461.htm http://www.businessweek.com/magazine/content/10_31/b41890509... It's about commodity ETFs so maybe index fund or other ETFs don't have the same problem, but the message I got out of it is that there are plenty of unknown unknowns here.
  - davidw 16y ago
    > "I make a living off the dumb money," says Emil van Essen, founder of an eponymous commodity trading company in Chicago. Van Essen developed software that predicts and profits from pre-rolling. "These index funds get eaten alive by people like me," he says. Yeah, that sort of thing is what scares me about investing. I don't want to do it full-time, but it looks like there are tons of smart people out there who do make it their job, and are out to get you.

patio11 16y ago

Bogleheads have known this for thirty years now. Buy index funds, people. Defaulting to Fidelity & etc 2 percent fee funds, like many do in their 401ks, will cost you literally millions over your lifetime.

bolu 16y ago
Sigh... so true. I only wish the economics were different. If, like Fidelity, you extract a ton in fees it allows you to swamp the airwaves with marketing dollars. And the folks who just keep their heads down and do their jobs, well, don't have as much money to run ads. And in this market, unfortunately, because few people understand it deeply ad dollars can move the needle. Unfortunate, to say the least. This is not even considering the who commissioned-advisor problem.
- patio11 16y ago
  On the Predictably Irrational blog there was an example of how clients recommended Fidelity and Vanguard evenly picked Fidelity on the basis of 25k bonus airline miles (cash value $250) so that they could pay $2~20k extra a year in management fees. I wanted to cry... And figure out how to offer airline miles.
  - bolu 16y ago
    It's because the fees charged don't appear as a line item on your statement. It's probably the only thing most American families spend more than a $1000 a year on (I did the math), for which they get no documentation... not even a receipt. Can you imagine how different the world would be (and how much less Fidelity would make) if you had to pay fees out of pocket? A single piece of simple legislation that disallows silently deducting fees from your assets would be all it takes. My co-founder and I sometimes sit at dinner thinking that if we do nothing else for the world but make fees (both expense ratio and more subtle ones like turnover-induced tax hit) more tangible, then we'll have succeeded.
    - InclinedPlane 16y ago