A lot has been made of the difference between ETF and mutual fund expenses, and for good reason. As the ETF world continues to expand, investors are granted hundreds of low-cost alternatives to many popular mutual funds. For example, the average equity mutual fund charges between 1.3% and 1.5%, while the average equity ETF charges just 0.57% [for more ETF news and analysis subscribe to our free newsletter].
The difference between a handful of basis points may seem miniscule within the confines of a year, but when you look at expenses over time, it is clear that ETFs have the potential to save you a lot of money. In order to get a better understanding of the concept, take a look at two hypothetical portfolios below.
Below we constructed a basic portfolio with five ETFs and one with five mutual funds; they both fill the allocations of global equities, emerging market equities, U.S. bonds, international bonds, and commodities. The two funds in each category have near-identical strategies but very different expenses. Note that we chose some of the cheapest mutual funds we could find that matched these popular ETFs, there are certainly more expensive options with similar strategies to the funds we chose.
| Gobal Equities (40%) ||VT||0.19%||VTWSX||0.30%|
| Emerging Market Equities (20%) ||VWO||0.18%||VEIEX||0.33%|
| U.S. Bonds (15%) ||AGG||0.08%||VBMFX||0.20%|
| International Bonds (15%) ||BNDX||0.20%||VTIBX||0.23%|
| Commodities (10%) ||DBC||0.93%||PCRAX||1.19%|
If you drag that portfolio out over time, the difference in returns can be quite astonishing; especially considering that the ETF/mutual fund pairs have nearly identical strategies or indexes. The following table assumes each portfolio gains 8% each year and then accounts for expenses. As time goes on, it is clear the impact ETFs can make.
Over a 30 year period, investors in the mutual fund portfolio miss out on $34,000 and see their returns shrink by 34% (based on the original investment of $100,000); a painful result considering how easily that money could have been saved using an ETF portfolio. Again, we would like to point out that this mutual fund portfolio is conservative and contains indexed mutual funds. Many products feature active management (which fail to beat the market more often than not) and charge considerably more than the aforementioned funds.
To help better illustrate the impact that fees can have over time, the chart below uses the same assumptions as above ($100,000 initial investment returning 8% each year) with portfolios of varying fees. As time goes on, the stark contrast between the portfolio value becomes more and more apparent.
Using our free ETF Screener, you can easily narrow down ETFs by objectives and choose the most cost friendly funds from there. Also, if you are looking for an alternative to your current mutual fund, our free Mutual Fund to ETF Converter Tool allows a user to enter in a mutual fund ticker and it returns ETFs with similar or near-identical investment objectives.
Follow me on Twitter @JaredCummans.
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Disclosure: No positions at time of writing.