The Expense Ratio That Cost My Parents a Car

We were supposed to be changing an address.

That was the whole job. My parents had moved, the statement still had the old address on it, and I said I would sort it out on a Sunday afternoon because it would take ten minutes. Then I turned to page four, where the fund’s charges are listed in a table that nobody is meant to enjoy, and found the number: 1.15% a year.

I asked how long they had held it. Since the nineties. A branch, a conversation, a form.

The sum I did on the back of the envelope

They had about $60,000 in that fund. Roughly twenty years before they expected to draw on it.

Say the underlying investments return 6% a year before costs. At the full 6%, 60,000 x 1.06^20 is about $192,400.

Now take the fee out. A 1.15% expense ratio leaves about 4.85% a year, and 60,000 x 1.0485^20 is about $154,700.

The difference is about $37,700. One holding. One number, printed in a table, on a document that arrives twice a year.

I said out loud that it was roughly the price of a car, and my mother said “a nice one,” and then neither of us said anything for a bit.

Why nobody notices, including careful people

My parents are careful. They saved steadily for decades. They did not panic in bad years. They did almost everything right. The fee slipped past them for the same two reasons it slips past everybody.

The first is that it is never billed. It comes out inside the fund before the price you see is calculated. The performance figure you read has already had the charge removed. There is no transaction to approve, no notification, nothing that interrupts your evening. In the first year, 1.15% of $60,000 is 60,000 x 0.0115 = 690. If a bank moved $690 out of the account in one transfer, there would be a phone call. Taken as a slice of the daily price, the same money leaves without comment, and it leaves again the next year on a slightly larger balance.

The second is that 1.15% sounds small. Market returns get quoted in whole numbers. Set it against that 6% and the fee is taking 1.15 / 6 = 19% of the return. Close to a fifth. That is the comparison that makes the size honest. No fund factsheet puts it on the front page.

What we actually did, which was less than you would think

We wrote down every fund they owned with its expense ratio beside it. Three funds. One was fine. Two were expensive for what they were doing.

Then, for each expensive one, a single question. Is this doing something a much cheaper fund could not do? Both were broad holdings tracking large parts of the market, which is a job an index fund does for a tiny fraction of that fee and has done for as long as they had owned them. The reasoning, and the careful version of the evidence on active against passive, is in index funds explained.

Then we checked the tax position before selling anything, because in a taxable account a switch can trigger a capital gain that costs more in the short run than the fee saves in it. In their tax sheltered accounts we moved without hesitating. In the taxable account we left the existing holding alone and simply pointed new money at the cheaper fund, which collects most of the benefit and none of the tax bill. The rules behind that choice are in tax efficient investing.

I want to name the part that was hardest. The arithmetic was the easy bit. My father felt foolish, and he had no reason to. He was sold a reasonable product in a branch at a time when cheap index funds were not sitting on a screen waiting for him, and nobody in the thirty years since had ever said the number out loud to him.

Here is your version of the job. It takes about twenty minutes this week. Find the expense ratio for every fund you own. It is on the factsheet and on your platform’s page for the fund. Put your balance and your time horizon into the expense ratio calculator and read the dollar figure, because the percentage is the thing designed to look small. Then ask, of each expensive fund, what it is doing that a cheap broad fund does not.

The costs that sit outside the stated ratio, including the sales charges some older funds still carry, are covered in expense ratios explained.