Importance of expense ratios

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jhsu802701
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Importance of expense ratios

Post by jhsu802701 »

The Boglehead consensus insists on a rock-bottom expense ratio when looking for ETFs and mutual funds to invest in.

I agree with this consensus for money market funds and bond funds. At the money market level, there's very little yield difference between one security and other. There's not much that a fund can do to boost the yield other than by cutting the expense ratio. (To be fair, there are lots of subsidies in place right now due to the microscopic interest rates. When interest rates rise again, Vanguard will be far ahead of everyone else.) In the bond market, securities of the same duration, credit quality, and prepayment risk have very little yield difference. Again, there's not much a fund can do to boost the yield other than by cutting the expense ratio.

When it comes to stock funds, I disagree with the Boglehead consensus of insisting on a rock bottom expense ratio over everything else. Of course, I'd never buy a fund with a high expense ratio (which rules out Franklin Templeton and T Rowe Price mutual funds), but insisting on a rock bottom expense ratio means ruling out many types of funds, including some great ones.

Vanguard's selection of international stock funds is limited. Do you want an emerging markets dividend growth fund? Vanguard doesn't offer one, but WisdomTree does. Do you want an international fund that specializes in companies with economic moats? Vanguard doesn't offer one, but VanEck Vectors does. Do you want a Japanese stock fund? Vanguard doesn't offer one, but WisdomTree does.

I'm not thrilled about paying a higher expense ratio, but I'm willing to pay a reasonable one for a type of fund that I cannot get elsewhere. Foreign stock funds have higher expense ratios than domestic stock funds. Emerging market funds have higher expense ratios than developed market funds. Small cap funds have higher expense ratios than large cap funds.

I just do not buy into the idea that future returns on investments are a random crapshoot.
DFJ: Japan - small cap dividend | DGS: emerging, small cap dividend | MOTI: international moat stocks | IQIN: large cap, developed | DGRE: emerging, dividend growth | GWX and FNDC: small cap, developed
Pandemic Bangs
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Re: Importance of expense ratios

Post by Pandemic Bangs »

jhsu802701 wrote: Sat Jan 23, 2021 3:48 pm I just do not buy into the idea that future returns on investments are a random crapshoot.
What is the question?

If you absolutely positively must have access to those subsectors ("wide-moat" this and that) then have it at.

Can you account for your confidence that those sectors will outperform and why your "need" to pay the extra ER is justified?

I can call any bunch of stocks my tech darlings of the moment, or I may have first-hand knowledge that some non-AI companies are going all-in on AI (my "AI Into The Future Fund") but that does not actually mean anything.
Wait 'til I get my money right | Then you can't tell me nothing, right?
BJJ_GUY
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Re: Importance of expense ratios

Post by BJJ_GUY »

jhsu802701 wrote: Sat Jan 23, 2021 3:48 pm The Boglehead consensus insists on a rock-bottom expense ratio when looking for ETFs and mutual funds to invest in.

I agree with this consensus for money market funds and bond funds. At the money market level, there's very little yield difference between one security and other. There's not much that a fund can do to boost the yield other than by cutting the expense ratio. (To be fair, there are lots of subsidies in place right now due to the microscopic interest rates. When interest rates rise again, Vanguard will be far ahead of everyone else.) In the bond market, securities of the same duration, credit quality, and prepayment risk have very little yield difference. Again, there's not much a fund can do to boost the yield other than by cutting the expense ratio.

When it comes to stock funds, I disagree with the Boglehead consensus of insisting on a rock bottom expense ratio over everything else. Of course, I'd never buy a fund with a high expense ratio (which rules out Franklin Templeton and T Rowe Price mutual funds), but insisting on a rock bottom expense ratio means ruling out many types of funds, including some great ones.

Vanguard's selection of international stock funds is limited. Do you want an emerging markets dividend growth fund? Vanguard doesn't offer one, but WisdomTree does. Do you want an international fund that specializes in companies with economic moats? Vanguard doesn't offer one, but VanEck Vectors does. Do you want a Japanese stock fund? Vanguard doesn't offer one, but WisdomTree does.

I'm not thrilled about paying a higher expense ratio, but I'm willing to pay a reasonable one for a type of fund that I cannot get elsewhere. Foreign stock funds have higher expense ratios than domestic stock funds. Emerging market funds have higher expense ratios than developed market funds. Small cap funds have higher expense ratios than large cap funds.

I just do not buy into the idea that future returns on investments are a random crapshoot.
I don't disagree with the larger premise -- that expense ratio should govern all decisions. I also don't subscribe to the idea that all investments must be passive.

If you are comparing these different alternatives with higher fees, I don't think it's a bad exercise to compare a rules-based ETF against an active manager as well as the lowest cost broad market index options.

I'm in the minority, but I do think there are times when the incremental expenses are warranted for a different approach.
Vanguard Fan 1367
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Re: Importance of expense ratios

Post by Vanguard Fan 1367 »

I have done well in Vanguard and Fidelity’s .03% or less expense ratio Total Stock Market Funds. I read Bogle’s Common Sense on Mutual Funds. He was not recommending international in the book.

I wish you the best as you invest.

Before I became a Boglehead I did quite well for a few years in a small cap fund with an expense ratio about 1.4 %.

So you can do well with higher expense ratios.
John Bogle: "It's amazing how difficult it is for a man to understand something if he's paid a small fortune not to understand it."
SantaClaraSurfer
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Re: Importance of expense ratios

Post by SantaClaraSurfer »

The challenge with mid to high expense ratios (I'd say roughly .2-.49 = mid range, and .5-.75 = high, I'd see everything higher as too much) are the "bargain" you make with the fund provider.

You're basically saying that a view to outperforming returns (or any other goal you may have) in the near term is worth you paying the ER for one, two, three decades, or more, during which your future returns may not be anything exceptional, or even might be less. Basically, it's a heads you win, tails I lose proposition, because you either get outperformance (if you don't, presumably you sell quickly and recoup your principal) or you pay the ER for as long as you hold the fund, and that eats into your outperformance.

The alternative is that you cash out and create a taxable event on those outperforming returns. And, of course the question in that case is when?

Our overall ER including our 401(k) and Tax Advantaged Bonds and Taxable Brokerage accounts is .089, which I can't really complain about.

But when we break out Taxable Equity Funds that number is more like .14, and, predictably, it's more like .317 for Taxable Bond Funds. (Though I'm working on getting that lower.)

I think the rubber hits the road when you start comparing recent top performing funds, which could be a TRBCX (Blue Chip growth) at .69% or something like ARKK (Tech Innovation) at .75% with the next most affordable funds in the same category, WCLD (SaaS/Cloud driven Tech) at .45% or RYT (Evenly Weighted S&P 500 Tech) at .4%.

What are you getting for your 29-35 basis points with ARKK or TRBCX? Will you still feel the same way after putting in $3,000 a year for 20 years? And where will those funds and managers be at that point?

Or will you look in the rearview mirror and ask yourself, further, why you didn't go with a more straightforward index fund like an FTEC at .084% or VITAX at .1??

Ultimately, what was the advantage you gained for the ER?

I think the most interesting aspect of this is simply, what is the investment you can make without question, never look back and stay invested in? ie. at what point does ER create a barrier to getting your dollars invested, which is the overall goal in the first place?

Or flip that. Someone who put $100,000 in ARKK last July would have $200,000 (on paper) now.

That's $1,500 per year. Twenty years from now, that's $30,000 in fees on your base investment.

What happens in the meantime? If ARKK goes sideways or collapses and declines in five years, you could easily end up with a declining investment that you're also still paying a premium for.

Personally, I think calculating your overall ER (and then also the breakouts) is a great way to keep perspective on this. I don't think it's necessary to be absolutist about the lowest fees, just keep your eyes open, do the math, and be smart about your choices long term.
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Tejfyy
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Re: Importance of expense ratios

Post by Tejfyy »

SantaClaraSurfer wrote: Sat Jan 23, 2021 6:39 pm I don't think it's necessary to be absolutist about the lowest fees, just keep your eyes open, do the math, and be smart about your choices long term.
When I found my way to the Bogle mindset, the math of ERs just made too much sense to rethink, overthink or mess with. I accepted it as the fact that it is and got on with other things in life. It's more about not wanting to occupy my mind with the potential of alternatives than anything else.
megabad
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Re: Importance of expense ratios

Post by megabad »

Yeah, as another poster said, you are basically thinking about the opposite direction of a boglehead. You are basically stating, “I am so sure this strategy/sector will outperform that I don’t care how high the fee is”. A bogle head would normally ask first how high the fee is and then ascertain whether he/she felt confident enough in the fund that it could overcome its fee.

In any case, in general I agree that if you believe a strategy will outperform its costs and all other strategies over your entire investment horizon, it makes sense to do it. However, I see no evidence leading me to support any of your rationing for those specific WisdomTree funds.

Dividends are a useless metric to me outside of taxes. “Dividend growth” has no meaningful consistent definition. “Economic moat” has even less of a meaningful consistent definition. And Japan is a relatively tiny, insignificant country in a global scale. You could exclude Japan entirely and still own 93% of publicly traded equities. Basically, if you could give me a better example, I might agree with you, but these aren’t options I like personally.
qwertyjazz
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Re: Importance of expense ratios

Post by qwertyjazz »

You have two points to your argument. One I agree with. The other I do not.
Expense ratios have gotten dramatically cheaper over the decades. An ER plus or minus 0.1 is probably not going to make that much of a difference.
But the higher ER investments you mention will on average will likely underperform in the long run. Unless you know something the market does not, buy everything and accept the average return. Some of those funds will do better - some will do worse with higher ER. But on average they will not be better.
G.E. Box "All models are wrong, but some are useful."
BJJ_GUY
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Joined: Wed Mar 13, 2019 7:45 am

Re: Importance of expense ratios

Post by BJJ_GUY »

megabad wrote: Sun Jan 24, 2021 1:21 am Yeah, as another poster said, you are basically thinking about the opposite direction of a boglehead. You are basically stating, “I am so sure this strategy/sector will outperform that I don’t care how high the fee is”. A bogle head would normally ask first how high the fee is and then ascertain whether he/she felt confident enough in the fund that it could overcome its fee.

In any case, in general I agree that if you believe a strategy will outperform its costs and all other strategies over your entire investment horizon, it makes sense to do it. However, I see no evidence leading me to support any of your rationing for those specific WisdomTree funds.

Dividends are a useless metric to me outside of taxes. “Dividend growth” has no meaningful consistent definition. “Economic moat” has even less of a meaningful consistent definition. And Japan is a relatively tiny, insignificant country in a global scale. You could exclude Japan entirely and still own 93% of publicly traded equities. Basically, if you could give me a better example, I might agree with you, but these aren’t options I like personally.
The cleanest example that comes to my mind is China A shares. Out total world index funds have nominal exposure to the second largest stock market in the world. This is an inefficient market led by retail flows, despite increased share of institutional investors now authorized to trade locally. The a-shares market index has large concentration in SOEs, and financials, and high concentration in the top handful of names. Finally, A shares index funds aren't cheap, and they don't have great liquidity or size (AUM of the fund).

So for these reasons, I think it is a very logical decision that one might be willing to pay more than 1% mgmt fee to gain access to a very inefficient market, that isn't as correlated cyclically other Developed markets. Because I find the index to be unattractive as constructed, it makes a lot of sense to pay to access an entirely new, incredibly large market, and the related economic growth that is passed through. Because of the vast number of stocks >3,000 onshore alone, and the majority of trade volume, which is often uneconomic, buying/selling activity being retail driven -- this all seems like the opportunity to earn returns over and above the A-shares market, and also returns on an absolute level that are beneficial to the total investor portfolio
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