Hefty Fees Weigh on Returns

When compared to passive funds, active funds charge higher fees. The cost of a fund’s operation is passed on to the investors. In the case of active fund management, the costs associated with identifying mispriced securities are burdensome. Detailed stock analysis, frequent buying and selling inside the fund, and compensation to the funds’ managers for their perceived skill all add up to impose a hefty fee and a high hurdle for fund managers to beat their benchmarks net of fees. As I have shown in previous steps, active managers rarely beat their index benchmarks. These higher fees are a primary culprit of this underperformance. Figure 7-5 reveals the disparity in mutual fund expense ratios, showing the weighted averages of fund share classes tracked by Morningstar. The figure shows the differences of the average fund expense ratios between actively managed funds, and a 60% Stock/40% Bond Index Portfolio. As you can see, the average actively managed mutual fund is more than three times as costly as the blend of indexes.

Figure 7-5

Step 7FeesSkillexchange-traded fundsETFsS&P 500