Friday, February 25, 2011

Costs Matter - Stick With Index Funds!

Mutual fund giant Vanguard announced that they're slashing some of their industry-low expense ratios on several index funds, including many of their international offerings. This is welcome news for Gen Y investors because it means that those of us who invest in index funds (and we all should!) get to keep more of the return that our funds generate.

Consider this: You invest in an actively managed mutual fund that charges a total of 7%; a 5% front end load is paid upon purchase of the fund and an additional 2% in management/other fees get tacked on as well. To make up for that immediate hit, your fund has to return 7% just to break even. Even worse, it's quite difficult for portfolio managers to consistently beat the market and even harder for investors to pick those managers who will!

Alas, it's not all bad news. Index fund purveyors like low-cost leader Vanguard, Fidelity and TIAA-CREF all offer index funds that passively track a market index and earn the return of the market, minus a very small fee. Whereas an actively managed fund may charge you 5%+, an arm and a leg indeed, index funds typically charge very minimal fees. In Vanguard's case, the expense ratio on their Total Stock Market Index (VTSMX) is only 0.17% - now that's cheap!

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