[Updated December 28, 2017 by David Dierking] If there’s one trend that has emerged over the past several years, it’s that investors are strongly preferring ultra-cheap mutual funds, and providers are more than willing to accommodate them.
The average equity mutual fund expense ratio has dropped from 1.04% in 1996 to 0.63% in 2016, while bond fund expense ratios have dropped from 0.84% to 0.51% over the same time frame. That’s great news for investors because lower expenses means more money stays in your pockets. Given the proliferation of target-date funds using these products, investors want to understand the cheapest options available to them since they often translate into greater risk-adjusted returns.
Mutual fund fees can be one of the biggest drivers in shareholder returns. Differences in expense ratios between funds can seem minimal on the surface, but those differences can add up to thousands of dollars over time. For example, the Vanguard Target Retirement 2045 Fund (VTIVX) is one of the cheaper TDFs in the marketplace with an expense ratio of 0.16%. Another highly rated TDF in the same category is the T. Rowe Price Retirement 2045 Fund (TRRKX), which charges an annual expense ratio of 0.74%. Assuming an initial investment of $50,000 held until the 2045 target date, the difference in ending account balances between the two funds is significant.
Investing in the higher-cost T. Rowe Price fund would cost an extra $25,000 over the life of the investment, but the opportunity cost missed by choosing the higher-priced fund is even greater. Money lost to fund expenses is money that doesn’t get to compound over time. In this case, choosing the more expensive fund option results in a $62,000 loss in investment value over 28 years.
What type of returns an investor sees on their investment will always be a guessing game. Choosing low-fee funds is the easiest way to control costs and improve your chances at greater risk-adjusted returns.
To gain a better understanding of how mutual fund expenses are trending, click here.
Attractive Low-Cost Target-Date Funds
The use of the 2045 target-date fund in each case is merely to give a single example in their respective TDF lineups. All options within their roster, from the in-retirement portfolio up to the 2060 target date and beyond, have similarly low expense ratios and should be considered depending upon your personal circumstances. Outside of low cost, each of these funds has the advantage of simplicity. The Vanguard, Fidelity and TIAA funds own just four mutual funds within their portfolios, while the Schwab fund has seven. Some TDFs have nearly two dozen individual fund holdings, making them needlessly complex and generally more expensive. The Schwab fund is still relatively new, at just over one-year old, but it follows the low-fee strategy employed by many of the company’s mutual funds and ETFs.
When looking for the cheapest target-date funds, the usual suspects usually top the list. Vanguard, Schwab, Fidelity and TIAA are all well-known for their broad menus of low-cost fund choices, so seeing them offering the least-expensive TDFs should come as no surprise. Here is a sample of some of their options in the TDF space.
To understand what to consider when choosing a TDF, click here.
The Bottom Line
While the expense ratio shouldn’t be the only consideration when choosing between different funds, it should be a primary one. Choosing low-cost funds is one of the easiest ways to keep your investment dollars in your own pocket and improve your overall risk-adjusted returns. Any of the above options would be an ideal choice if you’re looking to add a TDF to your portfolio.
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