Lower prices are often synonymous with value. Surprisingly, the same is true when selecting investments. Look for the lowest-priced, diversified exchange-traded funds (ETFs), the cheapest mutual fund or any investment vehicle or manager that ranks among those with the lowest costs. For top long-term returns, be more focused on the cost of your investments than in seeking the top-performing fund.
How can I make such a definitive statement? Because the research supports it.
Morningstar reports that the average actively managed stock mutual fund sports an annual expense ratio of more than 1.4 percent. (Compare that to the average ETF fund fee of 0.2 percent.) If we assume a long-term return on stocks of approximately 9 percent and an average annual inflation rate of 3 percent, we obtain a real rate of return of 5.8 percent annually. Before accounting for the compounding of the expense ratio — yes, fees compound and erode total return just as dividends and interest compound and increase total return — you can see that an average annual fee of 1.4 percent consumes a significant portion of the average annual real total return of stocks of 5.8 percent.
To continue reading click below: