Mutual Fund Fees

I just read an article in the Globe and Mail which shows Canadian investors as being the highest payers of mutual fund fees of any country in the world. My point is not debate whether mutual fund fees in Canada are the highest but the impact that fees have on performance and in particular, the compounding of returns over time. Here's an example:

The S&P 500 has returned 11.78% compounded over the past 20 years. $10,000 invested in the Vanguard S&P 500 Index fund 20 years ago would total $92,761 to the end of 2006 (current fees are 0.18% annually).

Now let's suppose that we invested that original $10,000 into an "actively" managed mutual fund whose performance matched that of the S&P 500 (by the way this not a small feat as studies have shown that most mutual funds do not beat the S&P 500 over long time periods). Also, we'll assume that fees are 1.5% per annum. This is being conservative as there are many funds in Canada that charge 2% or higher and hedge funds charge 2% as a base before performance fees. That $10,000 at 1.5% fees turns into $70,798 or 24% less than the index fund. If we were charged 2%, that amount becomes $64,668 or 30% less. Oh and by the way, I haven't even mentioned the "load" fees that can be quite substantial when one either wants to buy a new fund or sell an existing one.

I guess the bottom-line is (and Warren Buffett says as much): if you're an amateur investor with little in the way of time and temperament to analyze companies for investment, then the best way for that person to maximize their returns over time is to invest in an index fund. The other option is to find a great manager with a good track record of outperformance whose fees are not higher than the average mutual fund. Don't worry, there are a few out there.