Investing in low-fee funds will save you much, much more money than you realize. Low-fee funds, like ETFs and index funds, can save you $50,000, or $80,000, or even $200,000, depending on the size of your portfolio and the time it takes before you cash it out.
Read the full story: 4 Rules That Can Save You $40,000. Or, if you prefer short & sweet blog posts, continue on and read this excerpt:
Avoid high-fee funds.
One of the biggest investment mistakes people make is not looking at the fees associated with a mutual fund. This money silently, quietly seeps out of your portfolio. You never get a bill in the mail. You never pay it upfront. And so you never realize just how many thousands of dollars you pay for a high-fee fund vs. a low-fee fund.
Scenario 1: Let’s say you have $50,000 to invest in your account. You put it in a mutual fund and leave it there for 20 years. But you don’t check the “expense ratio” (a fancy word for “fee”), and as a result, you’re in a fund that charges a 1.19 percent fee — the industry average, according to Vanguard.com. At the end of 20 years, you’ve paid a whopping $49,621 in fees. Look closely at that number — that’s almost the same amount you invested to begin with!! (But you don’t know you’re losing it, because you never have to write a check … this fee is just silently, quietly deducted from your overall portfolio, in small amounts at a time.)
Scenario 2: Now, let’s say you have $50,000 in your account. You put it in a mutual fund and leave it there for 20 years. You DO check the “expense ratio” and find a fund that charges only a 0.23 percent fee. After 20 years, you’ve paid $10,489 in fees. This means you’ve saved $39,132.
Stick with Passively-Managed Funds, not Actively-Managed Funds.
There are two types of mutual funds: active and passive. An active fund is managed by a group of (usually) Ivy League MBA’s who have convinced themselves that they can do what almost no human being before them has ever done: consistently, over the long run, beat the broad market average.
In fact, active fund managers are so convinced that they’re smarter, stronger and better than the millions of other people trying to do the same thing that they’ll charge you a hefty premium to manage your money. (This is where that high fee comes from). Then — this is where it becomes a horrible deal for you — they get paid their hefty premium whether or not they actually beat the market average (and, statistically, they don’t).
This means you should put your cash in a passively-managed mutual fund: a fund that tracks a broad market — like the Total World Stock Market, or the S&P 500, or the Russell 2000 — without charging you high fees.
What’s an Index Fund?
The king of all passively-managed mutual funds are called Index Funds. Index funds literally track an index within the market and deliver returns that mimic the overall market performance. Want to invest in the entire U.S. stock market at once? There’s an index fund for that. Want to invest in all of the big markets in the world? There’s an index for that too. Okay, how about investing in the small companies of the U.S.? Yep, there’s an index for that.
If you’re invested in a U.S. stock market index fund, and the U.S. market rises 8 percent, your portfolio rises 8 percent. You’ll have to subtract a small fee, usually between 0.12 percent to 0.20 percent. Some funds, like Schwab.com, have recently started offering index funds with fees as low as 0.08 percent. This is much better than paying those hefty 1 percent fees — which add up to tens of thousands of dollars over time.
What’s an ETF?
Index Funds became so popular that they spawned Exchange-Traded Funds, or ETFs, the type of fund that has grown more in popularity over the last decade than any other fund. And it’s done so for good reason: functionally, it does exactly what an Index Fund does (track a broad index of the market), only it has even lower fees than index funds.
Better yet, ETFs have no minimum requirement (if it’s trading at $25 per share, and all you have is $25, you can buy one share). Index funds, by contrast, have a minimum requirement to get started — usually around $2,000.
The low fees, and the lack of a minimum opening amount, is because ETFs are technically not mutual funds — they’re registered, under the SEC, as baskets of stocks that can be traded in real-time throughout the day. This means that day-traders out there are buying and selling ETFs multiple times a day, hoping to “beat the market” (the greatest delusion in the history of Wall Street). Thanks to those guys who are buying and selling frequently, paying fees and commissions with every transaction, ETFs for the rest of us have the lowest fees of all.
The best way to invest in the market is to buy commission-free ETFs. These have low fees and they perform as well as the overall stock market.