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The Hidden Costs of Investing in Active Mutual Funds

I recently read an article penned by Jack Bogle (the founder of Vanguard Funds) in the CFA journal titled ‘The Arithmetic of “All-In” Investment Expenses’. You can find the article here.

Essentially, Bogle details how costly it is to invest in active mutual funds and how over a 40 year time frame low cost indexing can leave you with 65% more in assets compared to active funds (in a tax deferred account). Bogle goes on to detail the cost of an active fund to be somewhere in the neighbourhood of 177bps a year, compared to a typical index fund that costs about 6bps.

Management Expense Ratio:                     112bps
Transaction Cost:                                           50bps
Cash Drag:                                                       15bps

He then goes on to look at additional costs that typical active fund investors bear:

Sales Charges:                                               50bps
Tax Inefficiency:                                            45bps
Investor Behaviour:                                   120bps
Survivorship Bias:                            up to 136bps

And finally backs up the numbers by using data from Lipper, William Sharpe (Nobel Laureate) and David Swenson (Yale Endowment’s portfolio manager).

All in all it’s a very sobering read and if you are still using actively managed accounts or funds to try and meet your financial goals beware it may take you a lot longer to achieve them because of the above additional ‘costs’.

 

Joshua Matthews
Managing Partner
Photo credit: Lendingmemo.com


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