If you’ve dipped your feet into the financial education world, you’ve heard of expense ratios. Think of these as administrative fees… what the funds take of your investment to keep their own lights on. This number differs wildly from fund to fund (actively managed funds have higher expense ratios, index funds, the FI-friendly choice, have lower expense ratios). This difference isn’t super obvious at first glace. For most of us, 1% seems close to .25%, which seems close to .05%. But in fact, .05% is 20 times 1%. Again: A fund that charges you 1% collects TWENTY TIMES the fee of a fund that charges .05%. That is too many times! Give me my money! This calculator is excellent for illustrating this point more specifically.
In case you are too lazy to run your own numbers I’ll give you an example of the kind of calculation we’re talking about. Let’s say Maria has $100,000 in VTI, an EFT that currently has an expense ratio of .03. If she contributes $5000/year for the next 20 years she’ll pay approximately $3,374.39 in fees. Michael, however, puts his $100,000 in a similar fund, but this one has an expense ratio of .75%. At the end of his 20 years, he’ll have paid $24,212.80 in fees. It would be more fun to do these things with $20,000:
Take a friend on an Antarctic cruise.
Buy 500 lbs of spice drops.
Help stop the spread of malaria through the purchase of 10,000 long-lasting insecticide-treated nets.
Maybe you are thinking hold on. The reason those funds charge more is because they make more money (that is, they get a higher return, making the fee, well, very worth it). Many actively managed funds do beat index funds… in the short term. But we’re playing the long game, friends. Here’s a pretty clear explanation of how that whole thing works.
So go forth and check your expense ratios. If you can’t find them on your account page, you can simply google “expense ratio for ___.”
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