When you are investing for your retirement, every dollar counts. So that means every basis point in fees also counts. And small differences can mean the difference between tens of thousands of dollars over a 30-year period. And we will not even get into if you should invest in an actively managed fund or stay with a passively managed index fund. There is a reason why Warren Buffett and Jack Bogel advocate for passive indexed funds. And that reason is very simple, it is too hard to consistently beat the markets so do not even try. So all indexed mutual funds that invest like the S&P 500 are the same? Well, the answer to that is no they are not.
For this example and post, we will look at two of the more popular mutual fund companies, T. Rowe Price and Vanguard. Both have an excellent history and offer low-cost S&P 500 indexed funds. But things tend to end there as far as their similarities. Yes, both have basically the exact same portfolio make-up, and both have low fees. And both even have similar returns over the last ten years. So it should not matter which of these companies you buy your fund from then, correct? Well, not so fast.
First, we will look at T. Rowe Price’s Equity Index 500, ticker PREIX. The fund has been around since 1990 and since its inception has an impressive 9.44% return before fees. You would indeed be hard pressed to find an actively managed mutual fund that has that kind of return over the last 27 years. And since we are discussing indexed funds the fees associated with them are lower than most actively managed funds, and in this one’s case, the annual fees are 0.27%.
Second, we will look at Vanguard’s S&P 500 indexed mutual fund, ticker VFIAX. This fund is newer than our T. Rowe Price fund having only been around since 2000 when it was first released. And since its inception, it has returned an average 5.52% before fees. As for the 4% difference before fees, the additional bull market of the 1990’s easily explains the rather large difference. But Vanguard’s funds only cost a mere 0.05% in fees. That is a savings of 0.22% a year for the same basic fund.
Since these funds are started approximately ten years apart, we will not compare them since their inception as that would be like looking at two similar cars that were built ten years apart. While close they are not really all that easy to compare. So we will examine the returns for both funds for the last ten years or since 2008. T. Rowe Price’s fund had an annual return of 7.26% before fees and 6.99% after they are accounted for. Vanguard’s fund had a similar return of 7.5% before fees and 7.45% after.
So what does the difference in returns and fees mean for someone investing in say an IRA for a 30-year period? For our purposes, we will use the adjusted return after fees for a 30-year period investing $5,500 annually in our hypothetical IRA’s. Now the difference between the two funds is not all that big, less than 0.25% a year. Well, actually it is going to be an exact 0.19% annually. Surely that will not make a very large difference in our ending values?
Well here are the final figures after using the after-fee return for each fund for a 30-year period and an annual contribution of $5,500. The T. Rowe Price account will be worth an impressive $596,600, and Vanguard’s will be worth an equally impressive $653,025. The difference in the two from less than a 0.2% a year difference in returns is a nice $56,424.
While that may not seem like a whole lot, it could mean the difference between running out of money in retirement or having a little extra when you need it most. Now that you have seen what the difference is on two similarly passive managed indexed fund try to imagine what it would be in an actively managed fund that did not beat the market for ten years much less 30. And imagine what your return would look like with a more typical fee of 1.5% a year that actively managed funds charge. You would end up with considerably less than the $600,000 plus we obtained in our hypothetical example.
So you now know to not try and beat the markets with actively managed funds because passively managed indexed funds do just fine. And even a tiny margin in fees can make a $50,000 difference in the life of a 30-year IRA. So when all else in considered equal use passively managed indexed funds and go with the one with the lowest fees and let your money work for you over time and compound into something worthwhile.
If you have any questions or need any additional information, please feel free to leave a comment here or contact me directly.
