Impact of Fees: Mutual vs Index Funds

Tony Robbin’s did it again.  He sensed complacency and used a simple story to send a meaningful message.  That message is to wake up and pay attention to your financial well-being!

I have a question for you – can you tell me the difference between a mutual fund and index fund?  Just two weeks ago I couldn’t have told you that a mutual fund is actively managed by a person while an index fund is programmatically managed to align with the market.  Since a person manages the mutual fund, a fee is associated to it as payment for his/her service.  In fairness, index funds also have fees, but substantially less – like $.60 for every $1000, while managed funds can range from $2-12 for every $1000.  This adds up!

For reasons I can’t justify, and even though I have multiple “funds” in my 401(k), I never bothered to read the fine print.  I never knew that some of these funds were actively managed and had fees associated to them.  I’d like to think it’s because I naively believed that fund managers have my best interests at heart, but if I am honest, I have to admit that it’s because stocks, bonds and funds seem complex and confusing to me.  Almost like it would require more concentration and effort to understand the financial jargon than I cared to put out.

I am embarrassed to admit that because, really, I am admitting that my future comfort via the health of my retirement savings wasn’t worth my concentration and effort today.  And that’s a down right shame.

Cue in Tony Robbin’s and his book Money Master the Game.  In chapter 6 he shares a story of three friends in a section appropriately titled “Same Returns, Different Results – The Cost of Ignorance.”  These friends are all 35 and have $100,000 to invest.  They each invest in mutual funds which perform equally in the market with 7% annual returns.  The only difference in the mutual funds is the amount each friend pays in annual fees – one paying 3%, another 2% and the last 1% respectively.  At age 65, after 30 years, how much impact do you think these fees had?

  • Friend A had $324,340
  • Friend B had $432,194
  • Friend C had $574,349

That is a HUGE difference.  Much more than I expected for a difference of 2% in fees.  Are you as surprised as I am?

This inspired me to question my own accounts. The very next day, I researched how much of my portfolio was in mutual (managed) funds and how much was in index funds.  Over half was in managed accounts and I was paying over 2% in fees.  I did the math and assuming I left everything alone, at the age of 55 (because you know I’m working toward early retirement) I would have lost just over $145,000 in potential earnings due to paying fees.  Needless to say, I made account changes.

Now here’s the unsettling part – as if the above isn’t unsettling enough – fee payment does not appear as a transaction on your statement.  The places you find fee information is in fee disclosure forms and the fund prospectus.  Knowing this I asked several family members and friends if they could tell me the difference between mutual funds, index funds and the impact of fees.  Only one person could and he works on retirement accounts for a living.

I had to share this information because it’s high time we all ditch complacency and give full consideration to who our money is working for, because I for one, want my money working for me.

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