Mutual Fund Fees Matter

As I mentioned the other day, I’ve been thinking a lot about what’s changed over the years here at Acropolis.

Three years ago, we made our first investment in open-ended mutual funds. We were early adopters of exchange traded funds (ETFs) that operate like mutual funds in some ways but are a little more tax efficient, offer liquidity during the trading day and are often slightly less expensive.

Today, we’ve invested $250 million in open-ended mutual funds on behalf of our clients. Wow! That’s a lot of money moving in a short period of time.

The first mutual funds that we bought replaced an existing ETF with specific exposure to a single asset class. As it happened, the mutual funds was cheaper: 0.52 percent instead of 0.60 percent.

That’s on the high end in terms of cost, but this particular asset class is somewhat esoteric. The weighted average cost for an entire portfolio is between 0.20 and 0.22 percent.

So far, it’s proven to be a good move, the new fund has outperformed the old funds by an average of 1.5 percent per year.

Some of the replacement funds were more expensive. In a different, more common asset class, the fund we used was 0.15 percent and the new fund is 0.27 percent. That was a harder choice because we were increasing the cost of the portfolio.

Fortunately, the new fund has soundly outperformed the old funds despite the higher cost. My point isn’t that our new picks have outperformed our old selections since it could have gone the other way (although I am obviously pleased), but that cost is only one factor in choosing a fund. Yes, it’s a very important factor, but it’s not the only one.

We don’t have any immediate changes to our lineup, but there is one fund that I am watching closely for possible inclusion down the road. This fund costs 0.54 percent and would potentially replace three funds that currently cost 0.25 percent.

Obviously, the only way you can justify the higher cost is if you think that the new fund can outperform the old one (or old ones) by more than enough to cover the additional expense.

That’s a tough call because the increased cost is a certainty and the expected outperformance is anticipated but far from certain. All the testing, modeling and analysis in the world won’t tell you what’s going to happen in the future.

For some people the uncertainty is enough to choose fund with a lower cost. What’s the right thing for the client? Is the right thing to buy the cheapest option? Is it right to own the cheapest option when you think there’s a better, albeit more expensive, alternative?

I don’t want to paint us into a corner by always promising that our costs will be around 0.20 percent if we finds something that we think will produce better results.

Investing always involves decisions in a cloud of uncertainty and that’s okay, it’s our job. I just want to make sure that we aren’t being penny wise and pound foolish.

If we recommend or implement something that’s more expensive than what we’re currently doing, it’s only because we believe that it’s the right thing to do, knowing full well that we might be wrong.