Less is More

FINRA, the Financial Industry Regulatory Authority, formerly the NASD, has updated and improved their website with some very useful investor tools. The one I’m highlighting today is the Mutual Fund Expense Analyzer.
Some things you should know. This tool helps you figure out, in advance, what the entire cost of any fund you research will cost over the next up to 20 years.
This is NOT a historical performance comparison tool. You pick a rate of return, a dollar amount and a time frame and the analyzer will tell you what the fund will be worth AFTER the costs are accounted for. It adjusts for breakpoints, for share class types and includes ETFs as an option.
You can select up to three funds at a time and it will compare how much each would cost at the rate of return you chose, in the time selected. The differences are amazing.
The reason they don’t do it based on historical performance is simple. Historical performance is meaningless in predicting future performance. Meaningless as in useless, not applicable, tells you nothing and, in fact, biases you to believe that the past performance will be replicated in the future, which is dead wrong.
The analyzer is simple to use once you’ve gotten the hang of what it’s asking for in the steps it wants it. I explain how to use it at the end of this post. Here’s a summary of three funds I selected. One is a load fund from American Funds, one is a Vanguard no load, the third is an index ETF (Exchange Traded Fund.)

After 10 years, $10,000 investment earning 10%

Growth Fund of America $22,935.53 after $1,544.20 in fees and sales charge

Vanguard Growth Equity $23,691.30 after $1438 in fees, no sales charge

ishares S&P 500 ETF $25,705.17 after $149.65 in fees

What really struck me was that, even with a 5.75% upfront sales load on the American fund, the Vanguard fund didn’t do much better, because of the effect of the internal management fees. The ETF blew both the mutual funds away.
Again, this is NOT a performance measure. It is a cost measure, which matters, very much.
The reason the upfront load has less impact on the long term is not always simple to understand.
When you invest and pay a sales charge, you pay on the amount you invested, in our case $10,000. The internal fees, however, are ongoing and are based on the amount the fund is worth when they are charged. So, as the fund grows, the dollar amount of the management fee gets bigger. This is why the Vanguard Fund didn’t do all that much better on costs than the load fund in the long term. After 20 years, they actually cost more than the American Fund, and the net return on American had almost caught up to Vanguard.
Naturally, these projections have to assume that fees stay the same going forward. Most managed mutual funds have not lowered internal fees over the years, that's a whole 'nother discussion.
FINRA is to be congratulated for its efforts in this area. The sooner investors get it in their heads that past performance is unrelated to future performance, and that they price they pay, particularly the annual percentage that taps into their account, is exponentially more important than a “track record.”

Fees are the Death of a Thousand Cuts

Fees hurt a bit another way in that every dollar you take out of the account is a dollar less that is earning money. Mutual funds generally take their fees monthly.
You can see the evidence in the summary above. If you add fees back into to the final amount, you find that there are still differences in the results.
Taxes will also matter, though not addressed in the above analysis. That’s because mutual funds make annual capital gains distributions whether you want them or not. If you money is in a tax deferred vehicle, that might be okay. Otherwise you may have to pay tax which will come from your assets in some form.
Index oriented ETFs do very little buying or selling, some years none at all, thus no tax until you choose to sell.
Now you know more than most brokers. You know shopping track records is a waste of time. You know that there is no rational or even mystical way to “outperform.” You know that paying someone to outperform is pointless. (At least for you, the guy who gets paid likely thinks differently.) And you know that costs matter, quite a bit.
If you want to pay and advisor, that’s fine. Pay him or her for advice that you can use, like tax efficient vehicles, a good asset allocation program, making sure you stay on track, keeping you diversified and rebalanced appropriately. Do not trade, do not buy options, futures or any other derivative, do not pay ongoing fees unless you require a lot of monthly handholding. Then you should pay a nuisance fee of some sort because you’re being a nuisance.
BEWARE
Not all ETFs are cost efficient. Not all ETFs are merely proxies for unmanaged indexes. Lots of ETFs are merely mutual funds in disguise, trading, moving aound money, increasing expenses. I use index oriented funds with brand names. I ran the analyzer on the Claymore mid-cap growth ETF, I don’t know Claymore from a stump in the forest, and the expenses were worse than the mutual funds, twice as much as American’s and Vanguard’s on the funds in my example. I presume it was named after the Claymore mine, a particularly nasty device that remains concealed, like the fees in the fund. When the mine version goes off, it spreads shrapnel, killing or injuring anything in it's explosion path. The Claymore Fund works differently. It shreds your portfolio from inside. Think of it as a vampire that sucks just enough blood to keep itself fat while not actually killing the victim.
The FINRA mutual fund analyzer can save you from the ugly feeling investors get when they think they’ve bought into a good fund, but they just can’t seem to make any money.
It’s been a long slog through this blog. I thought the information important enough to justify the length.
Now, how to use the analyzer.

First go to www.finra.org (you may leave this page if you go there now, so you may want to read through to the end first, or open another screen and type in the FINRA website so you can refer back to these instructions.
On the top right is a tab that says “Investor Information” click it.
On the page that comes up, in the left column, it says “mutual funds” click it
You will see a selection that says “mutual fund and ETF expense analyzer” click it.
You will see a screen that lets you choose up to three funds. This is where you have to feed the beast in the order it wants to be fed.
Go to fund 1, in the dropdown, pick a fund family. I went to American Funds (there are several that start with American, just plain American funds.)
Click search. You do this so that the program can load all the American fund choices.
The drop down box beneath says ‘select a fund or share class.” click and scroll to the fund you want
I used Growth Fund of America, the “A” shares, click on the fund. Now your Fund 1 section should say American funds then Growth Fund of America.
You can enter two more funds if you wish, it’s not required. Of course you want to compare alternatives, so I went to Fund 2 and picked Vanguard Funds, then Vanguard Growth Equity Fund. Remember, you have to “select” Vanguard first, then make your choice of the Vanguard Fund you want. I used Vanguard because there is no load, or sales charge.
Finally I wanted to compare them in cost to an S&P 500 index, so for Fund 3 I picked ETF (which is the first choice in the fund list. Then I went to the ishares S&P 500 index fund. The standard index.
You’re almost done.
Enter your investment details, use any numbers you want.
I used $10,000
10% rate of return
10 years
I must lack imagination.
Click on “calculate my expenses.”
Up pops a report which explains how your $10,000 investment would do if each fund returned 10% for the time you selected, in my example 10 years.
Suffice it to say, the price you pay for the fund, both sales charge and internal management fees dramatically affects results. You can think it in your head, seeing it in color is an eye opener.