TL;DR: Administrative fees suck. Download this spreadsheet to help evaluate investments.
Administrative fees can be one of the biggest discriminators between a successful investment strategy and one that leaves you greeting Walmart patrons in blue shorts and a stylish yellow vest
Administrative costs consist of all the overhead needed to maintain a fund: management salaries, fees related to regulation, printing expenses, etc. While these fees may be assessed daily, they are typically expressed as an expense ratio (an annual percentage of your balance in the fund that is removed to cover costs).
These fees can vary significantly. For example, Vanguard Total Stock Market Index Fund Investor Shares (VTSMX) has an expense ratio of .15%. On the other hand, VanEck Vectors BDC Income ETF (BIZD) has one of the highest expense ratios at 9.67%
How Much Will Administrative Fees Cost Me?
Over the long-run, even small differences in expense ratio can play a huge difference in your effective returns. Remember, whether the fund gains money or loses money, you always pay the administrative fees. You also lose the opportunity cost associated with those fees. The $40,000 you spent on fees over the last 10 years could have earned you an additional $87,000 over the next 15 years at 7%.
The following graphics from our downloadable spreadsheet illustrate the difference between two identically performing funds with different expense ratios:
When are High Administrative Fees Worth It?
Another way of looking at this is to consider how much better a fund needs to perform to justify its higher expense ratio. For example, if you are deciding between investing $25,000 in a Vanguard index fund (VTSMX) and PowerShares Listed Private Eq. (NYSEARCA:PSP), you may want to use our spreadsheet to help you compare the effective rate of return including the expense ratio before you invest.
In this example, we’ll assume VTSMX has an average annual return of 7% with an expense ratio of .2%. We’ll assume PSP has an expense ratio of 2.31%. Due to the higher expense ratio and the loss of compound interest on those extra costs, PSP will need a much higher average annual return. In fact, just to break even, PSP will need an average annual return roughly 30% higher than VTSMX.
In other words, you need to feel certain that PSP will average more than 9.3% annual return for it to be a wise investment. Finally, remember that the annual return is never guaranteed but the administrative fees are. Once you’ve purchased shares in a fund, you’ll be paying the expense ratio even when the fund performs poorly and loses money.
The Spreadsheet and App
Click here to download a copy of our spreadsheet so you can run your own scenarios. Simply modify cells H4-H7 to reflect your scenario and hit enter. Both the chart and the table will update immediately. If you would like to have a web-app version of this spreadsheet, leave a comment. If there’s enough interest (pun intended), we’ll create a web-based return calculator that allows you to vary expense ratio, rate of return and other variables.
In conclusion, be very cautious when considering funds with high expense ratios. Fund performance is never guaranteed but administrative fees are inescapable. Please leave a comment and let us know if you’d like a web-app that allows you to compare different expense-ratio scenarios.
