Share Market

A common myth about mutual funds is that any reputable fund will perform well and fetch returns according to investor’s expectations, or even exceeding them for some of the investors. However, not all funds are created equal. When one buys a mutual fund, one has to pay some various kinds of charges.

All funds charge investors for expenses, which include management fees and other costs of doing business, such as legal charges, accounting charges, marketing expense, etc.. Those fees are expressed in a term known as the annual expense ratio — the percentage of assets that go toward operating a fund. These expenses are subtracted directly from a fund’s assets. The higher the ratio, the less is left over for an investor.

S&P recently did some research evaluating the performance of low-cost funds vs. that of the higher-costs funds. In eight out of nine categories, the low-cost fund outperformed their higher-cost counterpart. The average low-cost fund outperformed the typical fund by an average of 20 percent.

In order to see how much it affects mutual funds returns, let’s compare a few different domestic stock mutual funds:

Fund A: A Total Stock Market Index Fund which charges no sales load and has an annual expense ratio of 0.15%.

Fund B: An actively managed Mutual Fund with a 5.75% sales load and an annual expense ratio of 0.59%.

Fund C: An actively managed Mutual Fund with no sales load and an annual expense ratio of 2.03%.

In other words, Fund A is no-load, with low costs. Fund B does charge a sales load, but it has fairly low annual costs. And Fund C charges no sales load, but it has substantially higher annual costs.

Assume that you invest Rs. 10,000 in each of these funds and that over the next 30 years the market earns a 9% annual rate of return, the investor in each fund would end up with the following amounts:

Fund A: Rs. 127,307

Fund B: Rs. 106,258

Fund C: Rs. 75,485

An investor in Fund A would have almost 70% more money than an investor in Fund C. This example shows that costs really do matter!