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’.
Photo credit: Lendingmemo.com