Mutual fund expense ratios affect returns a great deal. An expense ratio shows how much money is being spent on administrative costs compared to how much is being invested. So the higher the expense ratio, the more money is being siphoned off in fees instead of ending up in your pocket.
The U.S. Securities and Exchange Commission (SEC) has issued an official bulletin to raise awareness of the full impact of high fees. It uses an example of a $100,000 investment averaging a 4% annual return over 20 years, which would more than double to just under the $210,000 mark with an acceptable 0.25% annual fee. A fund charging 0.5%, a seemingly negligible difference, lowers the end result by some $10,000. A 1% annual fee shaves off a whopping $30,000.
Higher Fees Don't Equal Better Funds
You don't get a better fund by paying more in fees. High-fee funds generally tend to underperform compared to their lower-cost peers. These funds sometimes also feature front-load fees, which are basically additional buy-in fees on top of the annual fee. If you put $100 into such a fund, it can charge a one-time fee of, for example, 3%. That means you only get $97 in your account right off the bat. Then, it charges an additional 1% annual fee on the remaining $97 starting on the day when the money lands in the account.
Determining what fees a fund charges can be difficult, as many companies are adept at hiding the actual costs. The Financial Industry Regulatory Authority (FINRA) offers a free fund analyzer that cuts through the fog of more than 18,000 mutual funds, exchange-traded funds (ETFs) and exchange-traded notes (ETNs) to make the fees being charged more visible.
(For related reading, see "Everything You Need to Know About Investor Fees.")