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Mutual Fund Fees

All mutual funds charge fees (some are hidden) to manage your money and high fees substantially reduce your total returns. Annual fees of one and two percent may seem small but such fees are deceptively large when you compute their arithmetic impact on long-term returns.

The examples in this article evaluate the effect of annual fees of a hypothetical mutual fund. The examples assume you invested $10,000 and received a six percent annual return. The annual fee in dollars is computed after the gain in dollars is computed for the year.

Effect of Annual Fees on Total Return - You Won't Believe the Numbers

The Total Value table shows the total return for different annual fees and years held. As expected, the total return decreases as the annual fee increases. For example, your initial $10,000 investment with no fees is worth $57,435 after 30 years. But with a 2% fee it's worth only $31,330. You give up $26,105 to have the mutual fund manage your portfolio. The figures seems impossible but the arithmetic is correct.

Total Value and Years Held
Annual Fee
Years Held	0%	0.25%	1%	2%
1	$10,600	$10,573	$10,494	$10,388
5	$13,382	$13,216	$12,726	$12,096
10	$17,908	$17,466	$16,196	$14,633
20	$32,071	$30,505	$26,231	$21,411
30	$57,435	$53,280	$42,485	$31,330

The impact of the fee increases as the number of years held increases and this impact is amplified as fees increase. This is due to the compounding effect. As the investment grows in value due to compounding the fees grow accordingly. Therefore, the higher the fee and the longer the investment grows the bigger the bite from fees.

The next table shows the effect of fees in percentages.

Percent of No-Fee Total Value
Annual Fee
Years Held	0.25%	1%	2%
1	99.8%	99%	98%
5	98.8%	95%	90%
10	97.5%	90%	82%
20	95%	82%	67%
30	93%	74%	55%

For example, the 10-year total return for a 0.25 percent fee is 97.5 percent of the 10-year total return for a no-fee investment. For 20 years the percentage is 95 percent and for 30 years the percentage is 93 percent. So a low 0.25 percent annual fee has negligible impact on long-term total returns.

The effect of the two percent fee is much more. For a 10-year holding period the total return is 82 percent of the no-fee investment. But for the 30-year period the total return is only 55 percent of the no-fee investment. High fees clearly have a negative impact on total returns particularly as the number of years held increases.

Total Fees

The Total Fees table shows the total fees paid. The total fees accumulate rapidly as the annual fee and the number of years held increase.

Total Fees
Annual Fee
Years Held	0.25%	1%	2%
1	$27	$106	$212
5	$149	$585	$1,146
10	$345	$1,330	$2,531
20	$947	$3,483	$6,235
30	$2,000	$6,970	$11,654

Calculate Impact of Fees

You can use the SEC Mutual Fund Calculator to compute the effect of fees on returns.

Conclusions and Recommendations

Fees, no matter how small, eat away at your profits. The longer you hold the investment the more you give up because of high fees. Therefore, avoid managed mutual funds. Instead buy index funds with very low fees.

Updated on February 24, 2005