The Truth About Mutual Funds: Fees vs. Returns | Hacker News Reader

The Truth About Mutual Funds: Fees vs. Returns

vuru.co

30 pointsvirincognito17 comments

As a layman who has done a lot of research, I have 3 pieces of advice for people investing their 401k/IRA:

1) No Load Index Funds.

2) No Load Index Funds.

3) No Load Index Funds.

Seriously people. If your fund selection is so poor in your company's 401k that they don't have a single No Load Index Fund, lobby your HR to get one added, and put your money in the lowest load Index Fund, and put only the very minimum in there to get your company match, and put the rest in an IRA at a company that gives you the option of a No Load Index Fund.

Can you explain what you mean by a No Load Index Fund? Can you give an example or two? Thanks.

A type of fee commonly levied on mutual fund investors is called "Load." It's a fee you pay either when you buy shares of the fund (front load), or when you sell them (back load). Load is evil and should be avoided.

Index Funds are mutual funds that are not managed. That is, there's no manager and team of assistants that spend time curating the assets in the fund. These peoples salaries and their trading activities cost money and that comes out of your gains.

Index funds are simple: Take a snapshot of the market, say the NASDAQ or S&P 500. Determine the total pie -- add up the market value of all the companies in the index. Suppose AAPL is 15% of the total value, MSFT is 10%, etc. Take all the assets in the fund and spend 15% on AAPL stock, 10% on MSFT stock, etc. Rebalance periodically as needed.

Index funds have historically out-performed most managed funds. There are some winners. Some managed funds that have huge market-beating gains. But trying to pick these big winners is not a sound investment strategy.

It's a mutual fund that's designed to follow a particular stock index. For instance, there are funds that will exactly mimic the Dow Jones Industrial Average, or Standard & Poor, or other such indexes. And there's a pretty large number of indexes, so if you have an interest in biology, or tech companies, or junk bonds, you can find an index for it.

Here's the Vanguard fund for the actual Dow Jones Index: https://personal.vanguard.com/us/FundsMSChart?Ticker=^DJI

As for "no-load", that means there aren't any fees taken out of your account. Mutual funds take fees from your account to pay for their trades, and it's usually 1-2%. Index funds are brain-dead to manage, so they usually have either a very low load, or no load.

Which is why most people buying funds should buy their index funds through Vanguard. It's not a sales pitch. This company, owned by the fund holders, is the lowest cost way to buy index funds. Probably the only lower cost way to own stocks is to buy them directly through the company via their dividend reinvestment programs, but then you aren't buying an index and you are wasting your time.

I'm always amazed at people who don't do do this or know about them.

I stopped trying to convince people that no matter how good "their guy" is, he has to do amazing to offset his fees. And not just be amazing occasionally, but be amazing all of the time.

If you dig into it, the math for mutual fund managers really just doesn't make that much sense at all.

+1, except where there is a choice between a big liquid ETF and a similar no load index fund I would in most cases pick the ETF for tax efficiency. (unless for IRA/401K, tax not an issue)

When you buy an index fund, you get a 1099 and pay capital gains taxes on any profits the fund takes any time it trades; also when you buy it you buy into the fund's tax basis, so if they bought all their stocks lower than where they are now, you would pay capital gains taxes based on where the fund bought them instead of from the price when you bought the fund. You might even take a capital loss and still have paid capital gains taxes.

see for instance http://etf.about.com/od/etftaxes/a/ETF_Tax_Benefit.htm

Comparing the returns of a basket of all mutual funds to the returns of one large-cap stock index over a highly volatile period isn't very meaningful. The mutual funds weren't even 100% equities, so you're partially comparing the returns of entirely different asset classes.

As the article mentions, it's impossible to invest in the total mutual fund market. There is no index fund of mutual funds, nor is there any need when you can diversify across the entire market through existing index funds.

See also The Arithmetic of Active Management: http://www.stanford.edu/~wfsharpe/art/active/active.htm

If you're interested in a very good exploration of this topic(in the broader context of managing a large endowment), David Swensen's book Pioneering Portfolio Management is worth a read. Swensen manages Yale's very successful endowment and has been a thought leader in investment management. He is also an outspoken critic of actively managed mutual funds and supports his argument with solid data.

he also has a book for individual investors, 'Unconventional Success', which is very good, and also skewers active fund managers.

the opportunities in the context of an endowment are somewhat different from those facing individual investors, ie alternative investments are less practical, tax and time horizon considerations are different.

"We chose to look at this figure instead of the compounded return because individual investors often move from one fund to another."

Comparing returns over 10 years without re-investing dividends is just not right.

Hedge funds are in the same situation, and their fees are even higher - fees of 2% of total Assets Under Management PLUS 20% of any gains are common. For all of that, they have experienced challenges beating indexes as well (down 6.4% for 2011, as measured by the Dow Jones Credit Suisse All Hedge Index - according to the article linked below).

http://www.forbes.com/sites/greggfisher/2012/01/23/chasing-t...

Hedge funds' original purpose was to stay negatively correlated with the market, not to beat it consistently. Each is hard enough that doing both probably isn't possible, and it seems to me they aren't keeping their clients' expectations realistic.

If you invest for n years and the fee is i%, at the end of the period you will have paid n x i% of the average balance.

or, compared to the final amount you would have had, the amount foregone with compounding is 1 - (1- i) ^ n.

a big number. for instance, after 30 years, for every dollar you would have had without fees, at 1% fees you would have 76 cents.

(for sufficiently low i, (1- n*i) would be a close approximation, but the fee i is usually not low enough LOL)

It is surprising that mutual fund returns, after fees, were better than the S&P.

It is hard to tell unless all the funds in question only picked S&P tracked instruments. It could be for example, that some funds invested heavily internationally so international market in general delivered better returns than S&P tracked market?

That is why I prefer IT's with TERs much less than the ones charged by open ended UT.

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