25 Rules to Grow Rich By #9: Mutual Fund Fees

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The Simple Dollar is running a series in which we re-evaluate Money Magazine’s “25 Rules To Grow Rich By”. One “rule” will be re-evaluated each weekday until the series concludes; you can keep tabs on the action at the 25 Rules index.

Rule #9: The most you should pay in annual fees for a mutual fund is 1% for a large-company stock fund, 1.3% for any other type of stock fund and 0.6% for a U.S. bond fund.

As soon as I start seeing arbitrary numbers, flags start going off. On what basis do these numbers exist? What if you find a large-company stock fund that beats the S&P 500 by 2% but charges a fee of 1.3%? This rule says that you should never invest in such a fund, but I, for one, would invest in that fund immediately.

The truth of the matter is that there’s a much easier way to determine whether a fund is worth investing in or not. Do your homework. Before you even think about investing, know what is in the mutual fund and how it compares to common indexes (both general and specific).

If you want to compare some numbers, all you have to do is just subtract the fees from the rate of return and use this as the basis of comparison. If a fund charges a high fee but has a stellar track record, don’t be afraid to invest in it; however, if you can beat a mutual fund with a tiny fee by investing in an index fund, there’s no reason not to go with the index fund, even though Money’s rule “allows” you to invest in that mutual fund.

In short, the numbers tell you what you need to know; there’s no reason to remember silly metrics such as these. Let’s rewrite the rule.

Rewritten Rule #9: The only way you should compare mutual fund returns is by first subtracting the fees off the top of any fund; this will expose the true value of the fund.

You can jump ahead to rule #10 or jump back to rule #8.

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2 thoughts on “25 Rules to Grow Rich By #9: Mutual Fund Fees

  1. Your rule only allows one to compare based on past performance, and as we all should know by the required legal disclosure, that is not a guarantee of future returns.

    For actively managed funds. Your rule is probably as reasonable as can be formulated.

    But for passively managed funds, you should choose one of the lowest fees available. For some broad market indexes, that can be as low as 0.2%, but for less broad or more obscure indexes, it could be in the 0.5 to 1% range.

  2. Actually the basis for Money’s rule is the fact that a majority of funds that perform well in one period tend to fall near the bottom the next. Usually, performance is not exclusively indicative of the manager, but of the technique being in favor. However, by going with lower fees, you can maximize your return over the long haul, as they drag down performance.

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