Low Commission Investment Funds Are Not Only Good for Savings but Also Perform Better
We are fans of easy ‘set and forget’ investing . And that means investing in funds with low commissions that don’t eat up your profits. And a recent study by Morningstar found that funds with lower commissions tend to be more successful.
We’ve told you all about index funds and how they make investing simple and easy. Another reason to love them? They are usually cheap. However, some investors argue that their low commissions or expense ratios come at a price: you get lower returns over time. But new research from Morningstar has shown that low-cost funds actually perform better than more expensive, actively managed funds. It was enough for them to declare that “the fund’s collection is a strong and reliable predictor of future success.”
To gauge the success of a fund, they looked at historical data and how much the fund was making over time. Using this number and several other performance factors, they came up with a success rate to measure how well a fund performed over time, and what percentage of those funds survived and outperformed similar investments. Here’s what they found overall:
We found that the cheapest funds are at least two to three times more likely to succeed than the most expensive ones. Strikingly, our findings apply to virtually every asset class and time frame that we investigated, which clearly indicates that investors should be mindful of value no matter what type of fund they are considering.
In one example, the average five-year return on US equity funds with an expense ratio of 0.65% was nearly 11%. Similar funds with an expense ratio of 2.2% brought in only 8.8%.
Of course, the argument about correlation and causation can be made here. The fact that the fund is cheaper does not necessarily mean that it works better. However, there is an important relationship between performance and cost. And Forbes author John Wasick breaks it down :
Why are cheaper funds more likely to do well? In many cases, managers do not add costs by trying (unsuccessfully) to calculate the market. Their fees don’t gobble up the bottom line. This is why I invest them in my portfolios, including many Vanguard funds.
This is just another reason to use low fees in your portfolio rather than actively managed fees. Over time, they bring steady profits. For more details, check out the press release below and you can download the study from there.