How Bad Are Mutual Fund Fees?

When investing, there are three to keep in mind that can erode the purchasing power of each dollar that we have:

(1) The first one is inflation. If inflation runs at 4.0% annually, that means it will take $1.04 in 2014 to buy what cost you $1.00 in 2013.

(2) The second thing is taxes. If you own 1,000 shares of ExxonMobil in a taxable account, you will receive $2,520 in annual dividends. But, if you are in the 15% tax bracket, you will have to send $378 to Uncle Sam, effectively giving you $2,142 in oil well money from Exxon that you can use to spend as you please.

(3) The third way that you can lose money is by paying mutual fund fees. If you have $100,000 in an account that charges a 1% annual expense fee, you are paying someone else $83 per month in perpetuity to manage your money, and that figure will only grow up as your assets grow. Think of it like this: to break even, a management team would have to grow your assets by at $1,000 more than you (if left to direct your own investments) to be worth the cost.

Incidentally, this is a reason why the famous banker JP Morgan hated John Rockefeller back in the day. Morgan was used to getting his hands on other people’s money and charging them 0.5-2.5% of the total amount each year for the rest of their life. Rockefeller resisted these arrangements and was only willing to pay flat fees upfront, and this infuriated Morgan. Eventually, Rockefeller’s oil operations became so vast that he could fund all of his expansion efforts from his own profits, but there was a point in time in which Morgan was mad as hell that he couldn’t get an asset override on Rockefeller’s wealth, and you better believe there is a take-home lesson in that anecdote.

While I’ve got my mind on oil, let’s take a look one of the most successful energy mutual funds out there today, Icon Energy. These are the fund’s top seven holdings:

icon

Take a look at that. 9.28% of the fund is in Chevron and 8.83% of it is in ExxonMobil. Not to mention another 9.39% is in Conoco Phillips and its recent spinoff Phillips 66. At least 27.5% of the fund is in a combination of four stocks that we could easily pick out ourselves. Exxon Mobil makes $35 billion in annual profits across 48 different countries. It has been paying out an annual dividend tracing back to its Standard Oil roots with John Rockefeller in 1882. Do you really have to pay a management team 1.23% of your assets to figure out that Exxon, Chevron, Conoco, and Phillips 66 are good holdings in the energy sector?

Those fees add up—let’s pretend you’re near retirement, have that proverbial million-dollar portfolio, and want 15% of your retirement assets in energy companies.

If you put $150,000 into the Icon Energy Fund (ICENX), you have to give up 1.23% of your assets each year. That is $1,845 in fees for the first year. If you stuck with the Icon Energy Fund for a decade, you’d be paying at least $18,450 in fees to the Icon Energy management team.

Now let’s say you decided to be a self-directed investor and split that $150,000 into the obvious oil supergiants like Exxon Mobil, Chevron, Conoco, Total SA, Royal Dutch Shell, BP, and Phillips 66. What would your costs be in that situation? Assuming you used a discount brokerage house like Charles Schwab and paid about $9 per trade, you’d be looking at a $63 fee right off the bat, and no costs thereafter as you collected your big oil dividends without any interference from a third-party middleman.

Over a ten-year period, there is a huge difference between $63 in fees and $18,450 in fees. This is a reason why the 401(k)’s for a lot of people seem to go nowhere over a ten-year period. Giving up 1-2% of your wealth each year adds up in ways you don’t want to know over a ten, fifteen, twenty year period. If you just owned the underlying assets directly, you would cut out all of those obnoxious fees that act like a tapeworm on your portfolio, slowly siphoning off your long-term wealth. The greatest indignity of it all is that many of these funds that charge 1-2% end up owning the same companies that you or I could figure out by applying a seventh grader’s level of common sense.

This website is about getting out of the habit of transferring your wealth to other third parties on a regular basis and shifting the balance of power so that *you* have hundreds of dollars showing up in your checking account on a regular basis. With the exception of Social Security and a pension for a few of you reading this, your stock portfolio is what you will have to rely upon to make your dreams of financial independence come true. Don’t let others receive an override on your hard-earned assets.

 

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17 thoughts on “How Bad Are Mutual Fund Fees?

  1. Al Brockman says:

    Hi, Tim – I think you've only touyched the surface of MF fees. In addition to the stated fee, there are transaction fees, management fees, etc, etc, etc. Mutual funds should only be looked at as somewhat of a last resort. The other issue is the product mix of their holdings. You may buy a tech fund but do you really want 15% of your investment to be in Apple for example? While many funds have 100+ holdings, frequently the top ten represent a large percentage. I'm not sure that that is spreading your risk

  2. Monty says:

    Sorry but I love my Vanguard High Dividend Yield fund. Its worth the .20% fee for the diversification and I don't have to worry about the tax nightmare every year.. The way they built the portfolio was very similiar to my 20-30 stock portfolio as well. Instead of having a bunch of stocks for diversification, I hold 30-50% of assets in this fund. I also keep about 40% of my portfolio into 7 core stocks. I enjoyed having a very large portfolio (20-30 stocks), but it wasn't practical IMO. It was nice closing a ton of my Computershare accounts as well. I was never very happy with their slow purchases and poor support.

    Mutual Funds top Holdings

    Exxon Mobil Corp. 6.10%

    General Electric Co. 3.60%

    Chevron Corp. 3.50%

    Johnson & Johnson 3.40%

    Microsoft Corp. 3.20%

    Procter & Gamble Co. 3.20%

    Pfizer Inc. 3.10%

    AT&T Inc. 3.00%

    Wells Fargo & Co. 2.90%

    JPMorgan Chase & Co. 2.70%

    Coca-Cola Co.

    Philip Morris International Inc.

    Verizon Communications Inc.

    Merck & Co. Inc.

    Wal-Mart Stores Inc.

    PepsiCo Inc.

    Cisco Systems Inc.

    Intel Corp.

    McDonald's Corp.

  3. Monty says:

    My core stock holdings are COP, KO, MCD, WFC, SO and PG. I feel this portfolio offset my current holdings quite well. It was a good fit for my scenario.

  4. Monty says:

    One more point that I forgot to mention is using computer share or other DRIP companies to perform automatic withdrawls on 10-20 companies is a nightmare. They are not great when they pull out the investments at all different times of the month. It was a checking account nightmare for my wife trying to keep track of everything. Its incredibly smooth with this Vanguard fund. Heck if the market is down heavy one day I can click the buy button and it's processed that day. This option is good enough to offset the .20 fee. I can make that back by purchasing on down days alone! Don't get me long I find buying stocks much more enjoyable and will always keep 7-10 core stocks, but having a huge portfolio isn't very practical IMO.

  5. sameer syed says:

    Tim, totally concur and I have been applying your KISS common sense approach to investing and I am enjoying the fruits, much appreciate your blogs and sharing your wisdom! Take care, best regards, Sameer

  6. R says:

    Tim,

    I've been following you for a while and love your work! Im trying to sell some mutual funds that my former advisor bought in my account… It has underperformed the market and has a MER of 2.5%. The problem is that if i want to sell I will have to pay a 5.5% dsc fee. I want to start buying some dividend growth stocks, but find it hard to swallow that 5.5% hit. Any advice? Thanks!!

    1. Tim McAleenan says:

      It depends on your situation, but I'll share something Charlie Munger once said about bans on emigrants under the czar…if you are a good country, you would be completely open about letting people leave because you wouldn't fear it–you know you are great. If you are a terrible, miserable, wretched country, you would ban people from leaving, because you know that everyone wants to get out.

      It doesn't sound to me like those mutual funds can stand on their own merits. If they are good, they wouldn't fear leaving (in fact, good funds like The Vanguard Wellington shut down people from entering because the inflows are too high). Bad funds have to scare you into staying. Why do you think they put that 5.5% sales fee in there? I bet they know they are crap, and use the threat of the 5.5% sales fee to keep you on board.

      Personally, when I find myself making a mistake that I know will be costly to fix, I pay whatever is necessary and mentally categorize it as the tuition payment towards the school of life experience. I try to get the bad things out of my life as quickly as possible. I doubt ten years from now you'll regret selling that fee-laced fund. In my case, I like to remove the asset overrides from my life. I think I can figure out that Coca-Cola, Johnson & Johnson, Procter & Gamble, and ExxonMobil are good companies all on my own. But that's just me.

      I'm sure whatever you decide will work out well in the end. Awareness of what is going on puts you ahead of most folks out there.

      1. Tim McAleenan says:

        I agree with Ben. R, if you want, tell them that you find the fee outrageous, and request to have it waived. If they decline to waive it, I would be happy to write a lengthy piece spotlighting it, posting it on a Monday, and letting it hang for a while. Nothing pisses me off like when "moneymen" try to take advantage of good, honest, hard-working folks.

        1. R says:

          Tim, thanks for the advice. You are awesome.

          I suppose it's really my fault for being ignorant about the fee structure and letting my advisor do whatever. Ill probably take this as a learning experience and move on.

          To clarify, the fee to sell does go down each year, and reaches 0% after the 7th year. I'm only in year 2 so thats why it's 5.5% right now.

  7. tyc says:

    I think you made a mistake on number 3. If you want to break even with your fee, the asset need to grow at least at the rate of the fee inorder for your asset to remain the same (at $100,000).

  8. Mitul says:

    There are pros and cons of investing in a mutual funds, and just like the stocks, you have to do your due diligence. The biggest drawback of a mutual fund is that an investor of the fund own shares of the mutual fund, not the underlying securities. In my opinion, you should always look to be the owner of a "business." However, with that being said, there are plenty of low cost mutual funds to choose from, especially from firms like Vanguard. Through brokers, you can also choose a no-load or no transaction fee options as well. What matters is how much you're willing to invest in them, and what type, active vs index. For active you may pay higher fee, but there also quality options around .50%. It is up to the individual investor to choose on whether or not paying that fee to a manager can be justified, very few active managers can outperform the market most of the time. I am a firm believer in owning a portfolio of options with a mix of stocks and mutual funds. Also, a mutual fund can be a good option for individuals that cannot or will not put their time toward doing the work themselves. The recent scrutiny of high costs mutual funds have forced many fund companies to launch low cost options. Therefore, one should not ignore mutual funds all together.

  9. tyc says:

    I agreed with many things Mitul wrote. Yet, I disagreed that “The biggest drawback of a mutual fund is that an investor of the fund own shares of the mutual fund, not the underlying securities.” For example, you purchased a home by getting a loan from a bank. You really don’t own the home, but the bank until you pay off the entire mortgage. This to me isn’t a big deal or drawback.

    My biggest concerns on mutual fund are the various fees and how they are presented to investors. Yes, let many thing Mitul stated are true, but many investor do not look carefully enough at the various level of fees in a mutual fund.

  10. Carlice says:

    Wow, what a difference in savings on fees by doing it yourself with large cap stocks compared to mutual funds. I have been moving towards individual stocks such as those in your master list for the past few years.  I do have a large sum of money in a mutual fund that invests overseas in all sizes of companies and some alternative investments too. I am aware of the fees I pay annually for this fund but I do not know how to access these companies and obtain the diversification in my portfolio other than through a mutual fund.

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