How Much You Pay for Your Investments?

ETF (exchange traded fund) is a very young form of investment vehicle. While the history of closed-end funds goes back as far as 1774 (it was the creation of a Dutch merchant called Adriaan van Ketwich), the first open-end fund (the Massachusetts Investors Trust) was established in 1924, the first ETF was only launched in 1990.

Can you guess in which country was it launched? Yes, in Canada! This was the Toronto Index Participation Fund (TIP 35).

It took 3 years for their southern neighbor (for those who are not that good in geography, it’s the United States) to realize the benefit of this form of investment, so in 1993 the first American ETF (Standard & Poor’s 500 Depository Receipts) appeared on Wall Street. Asia only followed the trend in 1999 with the Hong Kong Tracker Fund.

From there onward the number of ETFs has started to grow exponentially. By 2017 the number of ETFs around the world is around 2,000 and the total value of their asset is over USD 2 trillion!

history of ETF

source: https://advisors.vanguard.com

As you can see ETFs are very new, but extremely fast growing form of investment vehicles. If someone is investing in the same way for decades, he might totally missed this form of investing.

One of the big advantage of ETFs is that they offer a simple form of investment into a wide range of assets for a generally low fee. And the trend is that these fees are getting lower and lower. At the time of writing this article, the expense ratio of Schwab U.S. Broad Market ETF is 0.03%, while you can also design a low cost, diversified ETF portfolio for 0.09%.

Related article: 4 ETFs for Dividend Investing

I have explained in another article why should you care about the expense ratio of your investments. If you haven’t done so, I invite you to read it.

Related article: The Importance of Expense Ratio

It is quite clear that you can waste a lot of money on management fees, and these can accumulate into a significant amount over the years. This is the reason why I was so surprised when I read an article on Meb Faber’s website. In this article the ratio between the assets held by the global asset allocation ETFs charging less than 0.3% vs the assets held by global asset allocation mutual funds charging over 0.3% was demonstrated with the below chart:

ETF vs mutual fund

source: mebfaber.com

It’s $2 billion vs nearly $1 trillion! In addition the average expense ratio of these mutual funds is 1.13%. This means that on a yearly basis $8 billion is paid out in extra to the mutual funds comparing to the fees that would come with ETF investing. And this amount only relates to a portion of the ETF/mutual fund world.

Warren Buffet’s Bet

Of course a higher fee would be justifiable if these mutual funds would deliver higher returns to their investors. But is this the case?

Well, Warren Buffet was so certain that low cost index funds would outperform the actively managed (therefore expensive) hedge funds, that in 2008 he made a one million dollar bet with Protégé Partners LLC. The bet covers a 10 years observing period which will end on 31 December 2017. The “race” is between Vanguard’s S&P 500 Admiral fund and the average return of five fund of funds (the exact funds are undisclosed to the public according to SEC rules). As per the end of 2016, the status looks like this:

Buffet bet 2016

source: http://www.berkshirehathaway.com/letters/2016ltr.pdf

Looks like Buffet is not going to lose this bet, which further proves that the high fees paid out to funds do not come with higher returns. However, based on Meb Faber’s above analysis many investors do not seem to understand this.

Dear reader, I give you a homework: Check your investments and if it contains any ETFs or mutual funds, please check the expense ratios and put the highest number to the comment field. I’m interested to see the results!

 

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Disclaimer: This post or any other information on the site is not intended to be and does not constitute financial advice or any other advice. I am solely sharing my idea, plan and progress on early retirement.

 

 

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6 Comments

  1. Four Pillar Freedom March 25, 2017
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  2. Dividend Diplomats March 28, 2017
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