When Jack Bogle started the Vanguard Index Fund, he essentially changed the investment management game forever. He found a way to reduce the fee’s they charged investors, which in turn, brought Vanguard more investment money than they could have ever imagined.
If the move to lower investment fees was the first landed punch in the fight against mutual funds, the rise of the Exchange Traded Fund is the nuclear bomb in the fight against mutual funds. And well to most market participants, the reason is clear, ETFs are way cheaper and easier for all parties involved.
But, why do lower fees matter? Yes, and the math, while perhaps not simple is straight forward. The idea is that if you invest the same amount each year, we will say $10,000, and in one scenario you pay 0.1% in fee’s and commissions and another you pay 1.5% in fees and commissions. Over 30 or 40 years of investing, the difference of 0.1% and 1.5% will add up because of compounding interest. How much of a difference, well that all depends on your annual return rate, how long you stay invested and how much you are investing, but it could add up to not thousands of dollars, or even hundreds of thousands of dollars, but millions of dollars.
Some quick back of the napkin math looks like this, just to prove my point. A 0.1% fee on $10,000 during one year is just $10. Now a 1.5% fee on $10,000 during one year is $150. Let’s say your account never grows higher than $10,000 over 10 years, (I know very unrealistic, but follow along.) If your fee’s where 0.1% you would pay $100 in fees throughout those 10 years, ($10 a year time 10 years). Now let’s say your fees where 1.5% on your $10,000 for 10 years, (and again it never changed from $10,000) you would pay $1,500 in fees over the 10 years. $100 in fees or $1,500 in fee’s, which would you rather pay? And again, that’s just on a $10,000 investment, imagine if you have $100,000, $500,000, $1 million or more invested.
So now that you know why fee’s matter, let this little nugget sink in’ the average fee for an equity mutual fund is somewhere between 1.3% and 1.5%, but could be as high as 3% depending on several factors. Investors can easily find actively managed ETFs with fee’s well under 0.75% and passively managed ETFs for fee’s at or below 0.09%, (you would be paying $9 a year on a $10,000 investment). And to be honest, ETF fees are even lower than that!
The Vanguard S&P 500 ETF (VOO) and the Vanguard Total Stock market ETF (VTI) each have fees at 0.04%. Furthermore, the new JPMorgan BetaBuilders U.S. Equity ETF (BBUS) has a fee of just 0.02%, undercutting several other ETFs which have recently lowered their fees to 0.03%.
Furthermore, many believe it's just a matter of time until ETFs start offering 0.00% fees or even some that may offer a negative expense ratio, (meaning they will pay you a small percent just for owning them).
The move to extremely low, if not zero fees altogether are going to slowly but surely take money out of mutual funds and put it in ETFs. At first, this move will be slow, as we are witnessing now, but once employer-sponsored 401(k) packages start making a move to ETFs and out of mutual funds, the move will dramatically pick up, and mutual funds will be running on life support. But the big shift won’t take place until 401(k) plans make the move.
The reason being is, the average DIY investor today is already likely using ETFs and not mutual funds. Some investors working with advisors are probably still using mutual funds, but as we have recently seen with JP Morgan Chase’s (JPM) filings, it would appear the big investment houses are slowly moving client money towards ETFs and away from mutual funds. This was shown in a 13-F filing released in November 2018 that shows JP Morgan was the biggest owner of its own ETF, the BBJP, with 96% ownership. It’s expected that money was likely all coming from JPMorgan’s client investment division.
It also should be noted that JP Morgan has its own mutual funds. So why wouldn’t they be putting their investor's money in those and not their newly created ETFs? Likely to be able to show their clients they are saving them money, as a way to keep them as clients.
But, as I said, the last punch from ETFs to mutual funds will not come until 401(k) plans start making the shift as a way to ‘save’ their client's money. And now that shift may not be a fast process, but it will eventually happen.
Disclosure: This contributor held JP Morgan at the time this blog post was written. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.