MY FINANCIAL advisor has been on a mission to reduce my investment costs. He’s been replacing my low-cost, broad-based index mutual funds with the exchange-traded fund (ETF) version. He believes this will improve my investment returns over the long run.
For instance, if you own Vanguard Total International Stock Index Fund—a mutual fund—you’re currently paying 0.11% in annual expenses. But Vanguard’s ETF alternative charges just 0.08%, equal to a savings of three cents a year for every $100 invested. That might seem small, but my advisor assures me it can translate into significant savings over time.
You purchase mutual funds directly from the fund company involved, with the price set as of the 4 p.m. ET market close, while ETFs can be traded whenever the stock market is open. I believe switching to ETFs is the right thing to do. But I had doubts about how large the savings would turn out to be. It’s hard to imagine saving three cents a year on every $100 can amount to a whole lot of money.
The upshot: Using NerdWallet’s mutual fund fees calculator, I decided to see how higher costs can impact a hypothetical $1 million retirement portfolio that enjoys 9% annual stock returns and 3% bond returns over a 25-year period.
I used Vanguard mutual fund and ETF expense ratios to determine the estimated 25-year cost, basing the calculation on a hypothetical portfolio with the following initial asset allocation: Vanguard Total Stock Market Index 35%, Total Bond Market Index 35%, Total International Stock Index 15% and Total International Bond Index 15%. Thereafter, no further money was added, and the portfolio wasn’t rebalanced.
Result? Check out the accompanying table. Keep in mind that the ETF cost excludes the modest sum you might lose to the bid-ask spread when you buy or sell an ETF. What can we learn from the table?
Dennis Friedman retired from Boeing Satellite Systems after a 30-year career in manufacturing. Born in Ohio, Dennis is a California transplant with a bachelor’s degree in history and an MBA. A self-described “humble investor,” he likes reading historical novels and about personal finance. His previous articles include 11 Remodeling Tips, Trust but Verify and No Vacation. Follow Dennis on Twitter @DMFrie.