The prospects of high returns can easily overshadow a mutual fund’s long-term costs. Investors must consider the risk taken when high returns are unpredictable but high investment costs are a sure thing.
A fund manager’s pristine track record is not a forecast of similar performance in the future — something no one can predict, especially with the volatile potential of the stock market.
As American investors begin to adopt the cost-cutting mindset following recent economic turmoil, the mentality is applied to investment portfolios so they can keep more of their money. By tackling costs, investors can rely less on stellar performance to ensure growth of their investments.
Of the fees involved, transaction fees and expense ratios have the most relevance to the average investor. They are the key starting points for anyone looking to curb costs.
Picking the Brokerage Firm
Choosing the the right brokerage firm is a daunting step for investors who are easily overwhelmed with the number of options available.
Investors who open accounts with a particular fund company will often face no transaction fees when they invest in the funds managed by that company.
For example, there is no transaction fee if a Vanguard accountholder buys shares of a Vanguard mutual fund. But, a Vanguard accountholder who buys or sells shares of a Fidelity fund will incur a $35 fee. Therefore, identifying the expected mutual fund investments will determine the brokerage.
Investors who prefer to invest in various funds from different companies may be better off choosing a discount brokerage where mutual fund transaction fees are low.
Watching Expense Ratios
Every mutual fund comes with an annual cost (expense ratio) that is deducted from the pool of money injected by investors.
Actively managed funds will carry higher expense ratios as fund managers make more of an effort to research and select investments that match the fund’s strategy. Index funds tend to have lower expense ratios since fund managers simply have to track a broad market index.
By choosing an index fund with an expense ratio of 0.5% over a managed fund with an expense ratio of 1.5%, investors already saved 1.0%, which means they don’t have to pray that an actively managed fund with perform well enough to cover that 1.0% difference.