Getting What You Don’t Pay For

By James McFarland, Senior Portfolio Manager.

Costs matter. Whether you’re buying a musical instrument, a new car, or selecting an investment strategy, the costs you expect to pay are probably going to play a big role in your decision.

People rely on a lot of different information about costs to help inform these decisions. I’m a classical guitarist, personally, and I also enjoy collecting guitars. When I go out into the market to look for a guitar to buy, there are a lot of costs to consider before making a purchase. Of course, there’s the sticker price, which tells me what to expect to pay for the guitar itself. But the sticker price is just part of the over all cost.

Other things like shipping costs, major or minor repairs costs, set-up and finishing costs, cost of accessories, on-going care costs, and any taxes can all add to the total bill. If I don’t make the effort to understand all these costs before making a decision, what seems like a good buy, might end up costing a lot more before the deal is done!

Investing in mutual funds requires the same kind of due diligence and care from investors. Since each investor has his or her own unique objectives, risk tolerance, time horizon and situation, there are different costs that need to be considered to understand how cost‑effective a strategy may be for a particular investor. Let’s go through several costs associated with mutual funds we believe to be important:

Expense Ratios

Many types of costs lower the net return it is possible for investors to achieve. On of these costs is the expense ratio. Similar to a sticker price, the expense ratio tells you a lot about what you can expect to pay for an investment strategy. Exhibit 1 helps illustrate why expense ratios are important and shows how hefty expense ratios can impact performance in a negative fashion.

This data shows that funds with higher average expense ratios had lower rates of outperformance. For the 15-year period through 2016, only 9% of the highest-cost equity funds outperformed their benchmarks. This may be slightly unexpected. After all, if someone charges you more for their services, wouldn’t you expect better results? I certainly would. But that doesn’t seem to apply when it comes to equity mutual fund outperformance. Instead, it seems that a high expense ratio is often a challenging hurdle for funds to overcome, especially over longer horizon.

Additionally, there is the simple fact that from the investor’s point of view, an expense ratio of 0.25% vs. 0.75% means savings of $5,000 per year on a $1 million account. As Exhibit 2 helps to illustrate, those dollars can really add up over longer periods.

High Costs can reduce performance

Hypothetical Growth of $1 Million at 6% Less expenses

While the expense ratio is an important piece of information for an investor to evaluate, what matters most when gauging the true cost‑effectiveness of an investment strategy is the “total cost of ownership.” Similar to the guitar example, total cost of ownership is more holistic than any one figure. It looks at things that are readily observable, like expense ratios, but also at things that are more difficult to assess, like trading costs and tax impact. It is important for investors to be aware of these and other costs and to realize that an expense ratio, while useful, is not an all‑inclusive metric for total cost of ownership.

Trading Costs

For example, while an expense ratio includes the fund’s investment management fee and expenses for fund accounting and shareholder reporting (among other items), it doesn’t include the potentially substantial cost of trading securities within the fund. Overall trading costs are a function of the amount of trading, or “turnover,” and the cost of each trade.

If a manager trades excessively, costs like commissions and the price impact from trading can eat away at returns. Additionally, excessive trading can also lead to negative tax consequences for the fund, which can increase the cost of ownership for investors holding funds in taxable accounts.

The best way to try to decrease the impact of trading costs is for funds to avoid trading excessively and pay close attention to effectively minimizing cost per trade. Employing a flexible investment approach that reduces the need for immediacy, thereby enabling opportunistic execution, is one way to potentially help accomplish this goal. Keeping turnover low, remaining flexible, and transacting only when the potential benefits of a trade outweigh the costs can help keep overall trading costs down and help reduce the total cost of ownership.


The total cost of ownership of a mutual fund can be difficult to assess and requires a thorough understanding of costs beyond what an expense ratio can tell investors on its own. Part of our job as investment specialists is to help our clients look beyond the obvious, uncover any hidden fees or costs, and evaluate the total cost of ownership of an investment strategy or fund. We then use this information to help our clients decide if a given strategy is right for them.




Data Provided by: Dimensional Fund Advisors LP.

There is no guarantee investment strategies will be successful. Diversification does not eliminate the risk of market loss. Mutual fund investment values will fluctuate and shares, when redeemed, may be worth more or less than original cost. The types of fees and expenses will vary based on investment vehicle. Investments are subject to risk including possible loss of principal.

Views and opinions are subject to change without notice. Data cited is believed to be reliable but is not guaranteed. This article is distributed for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Investing involves risk and past performance does not guarantee future return.