Why Investment Fees Matter

My investing career started when I was a teenager and my mother opened up a Roth IRA for me as soon as I had above-the-table income. (That is what you get when your mother is an accountant!) She asked me what I wanted to invest my money in and I replied “the S&P 500” because it was the only thing I had heard of. Looking back on it, that was a pretty decent choice, but it took me another 15 years before my understanding of investing went beyond a vague understanding of what a stock was. It was a good while longer before I learned about investing fees and why I should care about them.

What Are Fees?

When you invest in a mutual fund there is a cost associated with it. This cost pays for the fund managers who do their magic behind the scenes to make it easy for you to invest in hundreds or thousands of stocks with a few clicks in the comfort of your pyjamas. If you invest with anyone other than Vanguard, these fees also pay for profit and advertising and shareholder dividends and the like. 

As an example, let’s look at some different S&P 500 index funds and see what kind of fees they have. I’ll start with Vanguard’s fund VFIAX, as Vanguard is the low-cost industry leader. As expected, the fees, or expense ratio as it is known, are low. 

For comparison purposes I’ll next choose another S&P 500 index fund at random, PEOPX, and finally throw in the worst S&P 500 index fund of the lot, RYSYX. I’ll explain why it is so bad in a little bit. 

I’ve circled the expense ratios in the images above to make it easier to pick them out, but let’s summarize in a table. Let’s also translate an expense ratio into dollar amounts to make them more relatable. An expense ratio is the percentage of your invested assets you pay each year to the brokerage to invest in the fund. 

Fund	VFIAX	PEOPX	RYSYX
Expense Ratio	0.04%	0.50%	2.43%
Fees per $1k invested	$0.40	$5.00	$24.30

I’ve purposefully picked funds with a wide range of fees. The difference between 40 cents and almost $25 is huge, but you can reasonably ask “Why should I care that much?” After all, the costliest fund I show here isn’t even a nice lunch out these days. 

This is true, but this neglects two points. 

1. This is the amount you pay per thousand dollars invested;
2. This is the amount you pay each year, which becomes increasingly important as time goes on due to the power of compound interest.

I’ll illustrate this with some more math. Let’s say that you have $10,000 initially to invest and you are going to contribute an additional $5k each year for the next 30 years. This is a reasonable scenario for someone funding an IRA. I’ll use one of many online compound interest calculators to do the heavy lifting for me.

Initial Investment	$10,000
Yearly investment	$5,000
Average return rate	6%

Fund	VFIAX	PEOPX	RYSYX
Expense Ratio	0.04%	0.50%	2.43%
Fees per $1k invested	$0.40	$5.00	$24.30
Total invested	$160,000.00	$160,000.00	$160,000.00
Total Fees	$3,742.05	$44,506.64	$177,371.56
End Value	$472,701.25	$431,936.66	$299,071.74

Wow. Look at how the seemingly small differences in expense ratios add up over time. You would be $173k poorer investing in the RYSYX index fund versus its Vanguard counterpart. And the thing to keep in mind here is that these are all S&P 500 index funds – in theory the same thing! Just to drive the point home, I’ll show the same data in a visual format.

A 2%+ expense ratio is egregious and thankfully, fairly rare these days. But let’s not miss the 0.5% expense ratio and how it stacks up. While it is significantly better than the worst fund, over 30 years of investing you would still end up $40k poorer investing in PEOPX than if you had chosen VFIAX. $40k is nothing to sneeze at when saving for retirement. $40,000 is, in fact, a full quarter of the total amount you invested over the years ($160,000). So while expense ratios are arguably pretty darn boring, it is worth paying attention because these seemingly small numbers have an outsized impact.