MONEY OBEDIENCE

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Management fees, as the name implies, are fees that a fund management company charges for "managing" your money. As a rule of thumb, fees are higher if your money is managed "actively" which is the case with almost all mutual funds. Such a fund management company presumably puts more effort behind managing your money than if the money is not "actively" managed. For example, there are fund managers who research various stocks and make purchases based on what they feel will earn the best rate of return. The goal is to get higher returns for its clients' invested money. However, studies have shown that these efforts do not pay off for you, the client, certainly not once management fees are taken into consideration. Actively managed money usually leaves you worse off than money that is managed "passively" via index funds or exchange traded funds (ETFs). In fact, some of the overall better performance of index funds and ETFs is expressively due to the lower management fees index funds and ETFs charge!

In contrast to regular mutual funds, index funds and exchange traded funds (ETFs) are managed "passively". In case of stock funds it works like this. Instead of purchasing stocks based on an analyst's recommendations, stocks are purchased to match an index, such as the S&P 500 or the Dow Jones Industrial Average. Management fees of index funds and ETFs are lower, because there isn't as much time and effort invested by a fund manager in managing an index fund or ETF, whose moneys are invested automatically.

Let me show you briefly how fees affect your long-term performance. Just for the sake of an example, let's assume that both a mutual fund and an index fund will earn the same return of 11.05% in the long run. Say you can invest $500 per month either by buying a regular mutual fund or an index fund. The mutual fund will charge you an annual fee of 1.5% while the index fund will charge you only 0.20% per year. After 25 years of investing $500 per month you will end up with about $614,700 if you invested in a regular mutual fund. If you invested in an index fund instead, you would end up with about $767,800, a difference of $153,100! So, assuming that both investments earn similar returns, the fees make a huge difference in the long-run!