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My colleague Abhishek did an overview of how to look at investment returns (see here, here and here). Let me round out the series with a pet peeve of mine: fees.
Almost all packaged investments (mutual funds, ETFs, etc…) come with a built-in fee structure. Typically, passive ETFs have a lower fee (0.80% for NIFTYBEES, for example) and mutual funds average about 2% annually. So assume that you have a 10 year investment horizon. How do fees impact your total returns?
Lets assume that the market always goes up by 8% annually. So in 10 years, your IRR should be 8%, if you paid no fees. But it falls to 5.84% if you paid even 2% as an Expense Ratio. But the problem is that the market doesn’t go up every year but you will still pay that 2% to the bank.
Before 2008, fund companies estimated that the fees for closed-end funds averaged 6% of an investor’s return, the maximum by law for both types of funds, while the open-ended funds charged 1.75% on average.
The popularity of those high-fee funds back then shows that investors pay little attention to fees when they are amortized over the holding period. When it comes to assent management fees, fore-warned is fore-armed!
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