Costs

The Clear Advantage of Index Funds:
Comparison of
Costs of Index Fund vs Costs of Average Equity Fund *

At Evidence we review the historical underperformance of the average equity (stock) fund relative to its index fund counterpart. Here we examine the cause of that historical underperformance (and highly probable future underperformance), the enormous cost hurdle that an actively managed fund must overcome to add value in excess of the costs expended in the attempt to do so.

Please note that some of the costs detailed below are disclosed costs. For example, sales charges and fund expense ratios. Other costs are "hidden" costs, costs that are not required to be reported by the SEC, yet have substantial impact on bottom-line performance. Turnover costs and market impact costs are major undisclosed costs and much higher for the actively traded mutual fund than for its index fund counterpart.

The drag on performance represented by the costs outlined herein are extraordinary, particularly in an era when "gross" or pre-cost returns are expected to be at or below historical norms. Please see What a Drag elsewhere on this web site for a conservative analysis of the drag on performance incurred by the cost burden of the average equity mutual fund.

Estimated Cost Comparison: Index Fund vs Average Fund
The True Costs of Investing in Mutual Funds. Note! In every category of costs, index funds as a group incur lower costs than the average mutual fund.   Index Fund
(Large Capitalization) 		Average Fund (Large Capitalization)   Index Fund
(Small Capitalization) 		Average Fund (Small Capitalization)
1. Sales Charge or "Load"; Note! Sales charges are not assessed on true no-load funds; n/a 0.40% n/a 0.40%
2. 12b-1 Fee; a "distribution" charge; Note! 12b-1 fees are not assessed on true no-load funds; n/a 0.10% n/a 0.10%
3. Expense ratio; primarily the mutual fund managers' fees, plus administrative fees; 0.18% 1.30% 0.20% 1.60%
4. Turnover Costs; includes commission costs related to internal portfolio changes plus bid-ask speads related to internal portfolio changes; some funds "turnover" more than 100% of their portfolio each year; 0.03% 0.60% 0.25% 1.50%
5. Market Impact Costs; another "trading" costs related to turnover; relates to the impact the trade itself has on the security traded; 0.02% 0.30% 0.15% 1.00%
6. Cost of Holding Cash To Facilitate Redemptions and Other Purposes; 0.00% 0.10% 0.00% 0.10%
7. Increased Tax Impact From Portfolio Turnover In Average Taxable Mutual Fund; n/a 0.50% n/a 0.50%
Total Estimated Annual Cost: 0.23% 3.30% 0.60% 5.20%
  Index Fund
(Large Capitalization) 		Average Fund (Large Capitalization) Index Fund
(Small Capitalization) 		Average Fund (Small Capitalization)

* Note to Cost Comparisons: The above indicated sales load % is based on an amortization of 2% average front-end load over a four year period. Also, though common, not all non-index mutual funds have sales loads or 12b-1 fees. Also, the substantial turnover and market impact costs of non-index mutual funds assumes a substantial turnover of the mutual fund portfolio. This estimate assumes approximate turnover of 75% for the average mutual fund. Turnover is a natural function of the attempt of the average active fund manager to "attempt" to add value by selling ABC stock and buying DEF stock. Some fund managers have substantially lower turnover than others and the various estimated costs (commissions, bid-ask spreads, impact costs) would be reduced in such case. Many mutual funds are purchased in retirement accounts or by individuals in low tax brackets. In such case, the estimated "increase in tax" cost would not be relevant. In taxable accounts, however, the impact is considerable and a further "cost" of attempting to add value by engaging in high turnover thus creating tax liability.

The main point of this cost comparison page is to call to investors attention the often overlooked cost consequences of investment in actively managed mutual funds. These costs are the "hurdle" that active fund managers must overcome by their "expertise" to justify your paying them your hard-earned cash for the for their attempt to add value. Few active fund managers succeed, and most of these as a consequence of pure randomness or "dumb luck". See Fooled By Randomness elsewhere on this web site.