Mutual fund managers are very clever.
They express their management fees (called “expense ratios”) as a percentage of the amount of money you invest with them.
The average management fee for an actively managed fund (where the fund manager attempts to beat the returns of a designated index) is 0.67%.
The average management fee for an index fund that tracks the returns of a designated index is around 0.11%.
These fees seem inconsequential.
Surely, the difference between them can’t amount to much, right?
I used a handy calculator created by Larry Bates, the author of Beat the Bank.
Assume you invested $100,000 in an actively managed mutual fund that charged a management fee of 0.67% for 10 years. It earned 6% annually.
You would have a total gain of $79,085. But the 0.67% annual fee would have diminished the return you actually keep by $11,003, or 14%.
What if you made the same investment, with the same assumptions, in an index fund, that charged a management fee of 0.11%?
You would have the same total gain, but you would have kept a much larger portion of it as the 0.11% annual fee consumed only $1,850, or 2%, of the total.
You now understand why index funds are likely to outperform actively managed funds.