Costs and Outcomes: Like Playing Chutes and Ladders
When you were a child, did you play the game Chutes and Ladders, where each dice toss could propel you onward, plummet you back or advance you at a slow but steady pace? How you handle investment costs is like a game of Chutes and Ladders. Take care to minimize the drag of expenses, and you can get a leg up on achieving your end goals; ignore expenses, and you may find yourself barely creeping along.
Dimensional Fund Advisors has provided us with an important analysis of how debilitating high expense ratios and high trading costs can be to your desired expected outcomes.
In its 2013 Mutual Fund Landscape report, Dimensional describes: “Costs reduce an investor’s net return and represent a hurdle for a fund. Before a fund can outperform, it must first add enough value to cover its costs. … The question is not whether investors must bear some costs, but whether the costs are reasonable and indicative of the value added by a fund manager’s decisions. The data shows that many mutual funds are expensive to own and do not offer higher value for the higher costs incurred.”
In considering the impact of expense ratios, Dimensional demonstrated that, over time, funds with higher expense ratios lost ground – fell down too many chutes, if you will – compared to low-expense-ratio funds. See figure A.
Figure A: High Expense Ratios Make Outperformance Difficult
Measuring fund turnover, which is how much trading a fund engages in (which in turn generates added costs), the results were similar to measuring expense ratios. See Figure B. Results also were similar when considering bond funds instead of stock funds.
Figure B. High Trading Costs Make Outperformance Difficult
Please contact us if you would like a complimentary copy of Dimensional’s complete report. The analysis helps substantiate that, no matter how you spin the dice, among the most effective ways to elevate your investment experience is by lowering the costs involved.
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