Will investing in index funds protect me against paying too many fees?
I am going to retire soon and am pretty close to being debt-free. Should I put the vast majority of our money (one million dollars) in index funds to save thousands of dollars in fees? Or should I try to find something else?
Index funds are a great foundation upon which to build your retirment nest egg. If you are investing on your own, I would argue that you should use index funds exclusively. If you engage an advisor, their core holdings should be passive.
Be careful, though. Not all index funds are alike. There is still a wide range of fees. Mutual funds that track the S&P 500 have management fees that range from 0.03% to over 0.50%. Stick with providers that have a strong presence in the index space. Vanguard and Schwab are among the cost leaders in index funds today. While Schwab's in house index funds are not as extensive as Vanguard's, they've become a low cost player in the areas in which they compete. You should'nt have to pay more than 0.10% for indexed equity strategies.
In taxable accounts, you might want to consider using index ETFs rather than mutual funds. It's a technical point ... but you will likely find that your tax exposure is a bit less with ETFs than their analogous mutual funds. Good providers of ETFs include Schwab, Vanguard, State Street, and Blackrock.
Are you more interested in a professionally managed portfolio designed for your specific investment goals, time horizon,diversification, tax benefits and risk tolerance. Or, are you more interested in saving on fees.
There may be a reputation that the S&P 500 is hard to beat. At the start of 2000, the S&P 500 represented the most widely held asset class, large-cap U.S. stocks. This index had compounded at nearly 18% for the previous 20 years. And in the last half of the 1990s, it had compounded at 28.6%.
At that particular time, the index looked very compelling, although many who invested had regrets. Two major bear markets were among those reasons. But some important numbers will show others. The 15-year track records for the 10 Vanguard equity fund. All but two of those funds have 15 years of history; the exceptions are Vanguard FTSE All-World ex-US Small-Cap Index Fund investing in international small-cap stocks, and Vanguard Global ex-US Real Estate Index investing in international REIT.
Vanguard's 500 Index Fund at 4.1% (annualized), was the poorest 15-year performer among the five U.S. Vanguard funds. Only the Vanguard Developed Markets Index Fund (large-cap international stocks) did worse, at 2.6%.
Here are the 15-year returns for the other six funds:
- Vanguard Value Index 5.6%
- Vanguard Small-Cap Index 8.3%
- Vanguard Small-Cap Value Index 10.5%
- Vanguard REIT Index 12.5%
- Vanguard International Value 4.5%
- Vanguard Emerging Markets Stock Index 7.1%.
The first two of those numbers show that value stocks and small-cap stocks were better to investors than the S&P 500. This is consistent with the long-term performance for these asset classes. The third item on that list demonstrates that putting small and value together into the small-cap value asset class can potentially make a great combination.
While small-cap value stocks' annualized returns were 2.5 times as high as the S&P 500, the difference was much greater. The REITs fund had even higher performance at six times the gain from the S&P 500. I am not suggesting investors abandon the S&P 500, nor should they put everything into REITs or small-cap value stocks. I believe in diversification. Future asset class performance is unpredictable. I reiteratie my recommendation for diversification.
Chasing recent returns is one of the biggest mistakes in the mutual fund investment process dating back to early 2000. Many investors expected the S&P 500 to grow at 20% to 30% over the following decade. Whereas, if you diversify properly, you will not have to rely on any single fund or asset class.
Please read the attached article on mutual funds:
There is a common belief that investing in mutual funds is a conservative way to accumulate wealth in the stock market. We have all seen the cover of financial magazines that read: “Our 100 Best Mutual Funds for 2017.” Yes, magazine companies are in the business of selling their magazines.
If you are looking at whether or which fund to buy you usually look at its track record or performance history. Although we all know at the bottom of every mutual fund brochure is the disclaimer: "Past performance is not indicative of future results." Since most investors are dazzled by performance, I beg to differ. (For more, see: How Mutual Fund Companies Make Money.)
The first question should be: What are the costs? The annual cost of owning a mutual fund is called the expense ratio. There is also a separate charge called the sales load which I will cover later. The expense ratio is the percentage of the fund’s assets that go toward running the fund. But there are three additional components to be aware of:
- Management fees
- Administrative costs
- 12b-1 fees
Management fees or investment advisory fees go to pay the portfolio manager. You know it keeps up his Hampton beach house. Seriously, that is how he gets paid as well as from firm bonuses.
Administrative costs are for operating expenses like recordkeeping, client mailings, maintaining a customer service phone line, etc. These vary with the size of the fund.
Lastly, there is the 12b-1 fee. This fee is for marketing and advertising. Think about this fee when you see your fund advertised during Super Bowl half time. It also includes trailer commissions paid to the broker of record as an incentive to sell the fund. It works like an annuity for the sales person over the life of the fund. It is usually paid to the broker quarterly as it is taken out of the net asset value of the fund fractionally. I have even seen some funds that are closed to new investors and are still charging 12b-1 fees. (For more, see: 12b-1: Understanding Mutual Fund Fees.)
Regarding the sales load, mutual funds come in different share classes and this will determine whether you pay an up-front, back-end, contingent deferred sales load or no-load. The expense ratio usually differs with which share class you buy. Sounds confusing, doesn’t it? That is the way the mutual fund industry prefers it.
The bottom line is that these fees are rising as funds shift away from the up-front loads that are driving away sales and into the annual expense ratios where they are not as detectable. And these fees are charged every year whether or not the fund has performed. I have seen mutual fund holdings that have been held for years and the only one who has profited is the mutual fund company.
The other issue with mutual funds is the high turnover of assets in the fund. Buying and selling stocks have transactional costs which cut into the net return. A fund with a high turnover will end up distributing yearly capital gains to their shareholders and that will generate a tax bill for the investor thereby reducing net returns.
Additionally, mutual funds are required to maintain liquidity and the capacity to accommodate withdrawals. Funds typically have to keep a portion of their portfolio as cash. The funds are keeping cash balances of usually around 8% of the fund, which is not generating any returns. The average fund is charging around a 1.5% expense a year on the 8% that it is keeping in cash.
Mutual fund companies aggressively market funds awarded 4 or 5 stars by rating agencies. But the rating agencies merely identify funds that have performed well in the past. It provides no help in finding future winners. Historically, mutual funds have not outperformed the market. Research indicates that around 72% of actively-managed large cap funds failed to outperform the market over the last 5 years.
Mutual Fund Alternatives
There are alternatives to mutual funds that are structured differently and will also give you diversification. Unit investment trusts (UITs) are a fixed portfolio of securities usually with a 12 to 24 month term, therefore, no annual expenses only an upfront commission. Additionally, exchange-traded funds (ETFs) offer diversification and liquidity with lesser fees relative to mutual funds.
The bottom line is that mutual funds are not always the safe haven that they have been touted. The companies that manage mutual funds face a fundamental conflict between producing profits for their owners and generating superior returns for their investors. The best way to evaluate a fund is by digging a bit deeper into the fees and also looking at the turnover ratio prior to investing. It is important to understand the good and bad points. The probability of a successful portfolio increases dramatically when you do your homework. (For more, see: Mutual Funds: The Costs.)
Congratulations on your transition to a new chapter in your lives.
You have asked a good question and have no doubt found that there are numerous options.
You have a couple of different things going on here. Investing is but one piece. And you certainly can't go wrong over the long-term if you have funds invested in index funds. There are few things you can control when it comes to investing. One of them certainly is fees. This is from Vanguard: https://vanguardadvisorsblog.com/2017/04/25/why-active-vs-passive-is-the-wrong-debate/?utm_content=sf73662300&utm_medium=spredfast&utm_source=linkedin&utm_campaign=FAS&sf73662300=1
I'm a big fan of low-cost investing vehicles including mutual funds, Exchange Traded Funds and indiviudal dividen-paying stocks. But don't lose sight that fees are but one part of the equation.
But don't overlook the other piece of the puzzle: planning. While you can find a number of strong contenders for passive index funds at low cost (Vanguard comes to mind), what you'll need to consider is how to start withdrawing from these funds in such a way that you can sustain your retirement lifestyle anticipating inflation, possible future health care costs and the inevitable stock market pullback during retirement.
This is where you will do well to bring someone aboard who can provide you with this kind of holistic plan and support in implementing it.
Oftentimes, investment advisers talk about retirement planning in general and may say that they offer a retirement plan as part of thier investment services. Some do. Some don't. You should consider whether or not the adviser can provide comprehensive and competent counsel on a range of retirement issues: cash flow, tax planning for distributions, estate planning for your legacy, investment allocation and distribution advice.
You may want to speak with an adviser even if this person isn't directly managing your investments. Some (not all) registered investment adviser firms will offer a division of services so you may continue to invest through your own choice of platform or direct your own investments with perhaps periodic advice scheduled throughout the year to integrate investment changes into any plan.
Either way you should consider the positive value that a fiduciary financial planner can provide. Vanguard details this in a recent study at about 4% per year with part of the ($2,600/year) in the form of direct retirement planning services.
Morningstar once did a study of what factors determine mutual funds' returns. You would expect the Morningstar star rating system, right? No, they found expense ratio is the most important factor. Simply put, the higher the expense ratio, the lower the return. This makes sense: the bigger the slice the money manager take, the smaller the slice you get to keep. So you are right to focus on index funds since they are so much cheaper than actively managed funds. But not all index funds are created equal. There are expensive index funds as well. For example, the Dreyfund S&P 500 Index Fund has an expense ratio of 0.51%, that's 10x that of Vanguard or Fidelity. I suggest you stick with the big names: like Vanguard and Fidelity.
Generally speaking, less management in a fund means less fees, and fees compound over time!
No matter whether you're a seasoned investor or a novice at the stock-trading game, there's a popular option that may suit your portfolio-offering the stability of proven performers you know, plus the growth potential of innovative companies you may not have heard of yet. It also has additional benefits like low costs and tax efficiency.
QQQ-the trade name for the NASDAQ-100 Index Tracking Stock (NASDAQ: QQQQ)-is a type of investment product known as an exchange traded fund (ETF). With a trading volume averaging 99.7 million shares per day, it is the most actively traded, listed equity security in the U.S.*
Active investors appreciate the simplicity and liquidity of trading a basket of stocks in a single transaction. Long-term investors appreciate that the fund is based on NASDAQ's 100 largest non-financial companies and diversified across sectors. The investment covers a range of industries, including computer hardware and software, telecommunications retail/wholesale trade, biotechnology and transportation, with a simple purchase of a single stock.
Additionally, QQQ is eligible for 401(k) and IRA investments, making it attractive for a long-term buy-and-hold investment strategy. And because QQQ represents the collective performance of these companies, the impact of price fluctuations caused by a specific company is another reason QQQ is also attractive.
For the first time, investors who purchase the same dollar amount of shares at regular intervals can have direct access to an ETF such as QQQ. QQQDirect is an affordable online investing service that provides one plan purchase of QQQ per month free of any charge. It is a fractional share, dollar-based service that allows as little as $10.00 per month to be invested with QQQDirect's AutoVest Schedule.
"NASDAQ has played a significant role in the equification of America and QQQDirect is yet another way we can break down barriers to stock ownership," said NASDAQ Global Funds CEO John Jacobs. "By buying a single share of QQQ, dollar-cost average investors will own a portfolio of NASDAQ's industry-leading companies-including the likes of Microsoft, Starbucks and Dell."
"We believe this new service expands the ability of investors to make sound investment decisions," said John Markese, president of the American Association of Individual Investors (AAII). "As an advocate of investor education and empowerment, AAII views the introduction of QQQDirect as a new, cost-efficient opportunity for individuals to practice the principles of sound investing."