Generally, before we make a purchase, we shop and compare prices for the product we want to buy. We even get a little excited when we buy something at a really good price – we like to tell people about how well we have purchased. This comparison shopping often involves many factors besides price; but, almost always, price is a major consideration in our purchase decision.
Should we follow the same practice in our choices about investment products? The answer is a resounding Absolutely Yes!!
As I mentioned earlier, there are more factors than just price in our buying decision. However, today, with respect to making an investment purchase decision I am going to focus exclusively on price. I am also going to narrow our examination to the purchase of an investment fund, be it a mutual fund or and Exchange Traded Fund (ETF).
Funds have what are called an expense ratio associated with them. So, what is an expense ratio? The expense ratio expresses the annual cost charged by the investment manager of the fund to manage the fund and is shown as a percent of your investment. Well, what the heck does that mean? Let’s suppose you made a $1,000 investment purchase of a fund and the expense ratio was stated as 1.35%; that would mean that the investment manager would charge you $13.50 for every $1,000 you had invested in her fund.
Let me explain why I chose the expense ratio of 1.35%. According to the balance (located at www.thebalance.com) the average expense ratio for a Mid-Cap stock fund is 1.35%. At Cannon Capital Management, typically, our largest weighting in our client’s investment portfolios is in the Mid-Cap area. We use ETF index- based funds in our portfolio composition and the Mid-Cap fund we most commonly use has an expense ratio of .05%.
Let’s look at how our investment decision is affected by the cost we pay. We’re going to make the following assumptions as we compare two like funds – in this case two Mid-Cap funds.
Both return 8% per year before the respective fees or expense ratios are charged
One fund has an expense ratio of 1.35% and the other .05%
We start with an initial investment of $1,000 and add $1,000 to each investment at the same time each year for 30 years
Net return for the fund with the 1.35% expense ratio is 6.65% and for the fund with a .05% expense ratio it is 7.95%
After 30 years, the fund with the 1.35% expense ratio has a total value of $95,615; while the fund with a .05% expense ratio has a total value of $122,173 – a difference of $26,558, or 27.78% more in the lower expense ratio fund. Recognizing that price alone should not be the only factor to consider when making an investment purchase, this example illustrates why expenses matter in this decision process.
At Cannon Capital Management we keep a sharp focus on expenses – it makes a difference in the investment returns you keep and we believe that is part of Doing It Right!