Coming Back from "Vaca" with a Fee Rant

Well, it was sort of like a vaca -- in the last four weeks, I've managed to buy a house, form an LLC, and drive all night with two pets to my new (much more efficient and less expensive) home state of Washington!

I certainly don't want to offend all of my California-based friends, so I won't rant about the insane taxes there. Let's just say that forming an LLC will set you back $800 in the Golden State and run you $195 a couple of states north, and leave it at that. I'm already saving money, and you know how much that pleases a LMF4HMW! And yes, one of the major deciding factors in our move, other than my fiance's company so generously paying for all of our related expenses and packing, was the lifestyle change -- i.e., lower cost of living and opportunity to own a home. (More on that later -- those mortgage deductions are pretty fab.)

How does the above diatribe help other LMF4HMW readers? Well, it doesn't. It's a lame excuse for why I haven't written in a month :)

Let's get down to business. Today's post is all about fund fees. (These are the funds you pick in your 401k.) 401k fees are typically two-fold: 1) particular mutual fund's management fee or more generally, expense ratio; and 2) administrative fee for the plan. Unfortunately, there's not much you can do about the latter -- it's either take it and revel in the many benefits of a 401k (tax, growth, auto-pilot, etc.) or be very silly and not invest. Unless you're involved in the benefits department and can therefore rightly search for a lower cost plan for your company!

So we'll tackle the fee over which you do have some control, the expense ratio! The expense ratio is the percentage of money invested in the fund that goes to running it. Typical annual expenses include research, taxes, office costs, etc. and of course the monies paid to the fund manager (people in the business aren't prone to staying at Best Western and eating at Denny's). They typically range from a very low less than 0.25% for domestic index funds up to 2+% for emerging markets funds. Some funds market themselves as "low fee"; others as "high return" (usually higher fee). How they're contrived is not an exact science. (Sounding a bit like calculating the AMT, right?) Actually nowhere near as confusing, as again, you hold the reins here!

The fund manager's job is to make money. Your job is to choose an appropriate funds with relatively low expenses. While you'll only have a slightly greater chance of success calling the Vanguard or Dodge and Cox manager and asking him to lower the fee than say, getting customer service from a cell phone company, you do have the option to choose which funds in which you invest. And fees are a major consideration! The more dough lost to fees, the less your money will grow.

So look at the fund's prospectus (it'll be online) and search through the several pages of "blah, blah, blah" until you see "total expense ratio". This is the metric with which to compare the funds up for grabs in your 401k. Note: some of them will have a whole host of other fees like 12b, etc. You focus on the TOTAL expense ratio.

Ideally, you want a fund that's beating its benchmark -- the index to which it compares itself, net of fees. This means that the return from investing in the fund is better than the benchmark index even considering the monies paid out for expenses. If none in the group do so, choose the closest options.

Do I seem like a stickler? I am! There's just no reason to invest in a fund that isn't beating its benchmark net of fees. Why? Because a lot of you are lucky enough to have index funds, my absolute favorite thing finance. And the topic of my next post!

P.S. - do not be surprised if none of the funds available beat their index benchmarks. One of my most interesting reads in a Portfolio Management class was a research article hypothesizing about whether it's 40, 70 or 90 percent of actively managed funds that do not! Let's just say the finding was on the high end and open a bottle of Chateau Neuf du Pape, a blend of up to 13 different grapes that hails from the Southern Rhone in France, in honor of this weekend's Rhone Ranger's festival in San Francisco!