Fees Are Important, But Fees Should Not Be a Primary Discriminator

Fees matter to investors, in large part because compounding even seemingly small amounts makes a big difference over the long term.

However, fees should only be examined in their context.  Fees make a difference only when all else is equal.  When comparing funds that are reasonably expected to have similar performances over the timeframe of the investment, fees can make a difference.  But when comparing funds that are reasonably expected to have dissimilar performances over the timeframe of the investment (such as an actively managed fund versus an index fund), it is possible that an investor is better off paying the higher fees.

Sometimes you get what you pay for, and eliminating a good fund from consideration merely because of higher internal expenses can be foolish.  Remember that intermal expenses are embedded in fund performance numbers, which means that the total returns include those charges.

For example, if Fund A will have average annual returns of 10.0% and charges 1.5% (which are included in the returns) and Fund B will have average annual returns of 8.0% and charges 0.5% (which are included in the returns), Fund A with its fees that are three times larger is the better value.

Of course, this involves the difficult task of estimating the future numbers and perhaps projecting past performance which is no guarantee of future performance.  These alone can be reasons enough to consider index funds (which have lower costs).  But in areas of the market that are less efficient, paying up for a well-managed active fund can be worthwhile.  Alas, investors may never get a chance to consider such funds if they screen out higher fees too early in the process.

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Source:  Five Big Mistakes Mutual-Fund Investors Make

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