Saving Pennies or Dollars is a new semi-regular series on Money360, inspired by a great discussion on Money360’s Facebook page concerning frugal tactics that might not really save that much money. I’m going to take some of the scenarios described by the readers there and try to break down the numbers to see if the savings is really worth the time invested.
Kelly writes in: My husband I have lots of hobbies/interests and finances do not excite either of us so we are not savvy. We are great savers but don’t really know what to do with the money. We have our retirement accounts through work (Fidelity) and an emergency fund in a high interest checking account. In addition we had about $60,000.00 (that we don’t have plans for) in Vanguard money market funds until the rates dropped and we were not earning any interest. Because there is not a Vanguard office near our home (and we did not know where to put the money) we met with an advisor at Fidelity. We moved the money into stock market accounts and have made a significant amount of money. I have heard and read that Fidelity has higher fees than say, Vanguard, but if we can meet with an advisor yearly and are making significant money on this money do you think it is worth it? Or, is there a way to figure out what funds to put the money in at Vanguard? Are we talking about saving pennies or dollars?
In this instance, you’re comparing apples to oranges. Comparing a Vanguard money market account to a Fidelity stock fund isn’t even close to a realistic comparison. Money market accounts are typically invested in things that would be considered ultraconservative, like U.S. treasury notes. On the other hand, stock funds are invested in the stocks of companies and, by their very nature, are much more volatile, with big gains and big losses within the realm of possibility.
The only way to really gauge the impact of investment fees is to compare identical investments from two separate investment houses, which is extremely difficult since it’s rare for two investment houses to have identical offerings. Even if you compare very similar investments, like the Vanguard 500 and the Spartan 500, it’s still not an exact comparison because of small variations between the funds.
For example, with the funds above, the basic level investor shares of the Vanguard 500 has an expense ratio of 0.17%, with Admiral shares (with a minimum investment of $10,000 required) havving an expense ratio of 0.06%. The Spartan 500, offered by Fidelity, is somewhere in the middle at 0.10% (but has a $10,000 minimum investment). This gives an overall nod to Vanguard based solely on the expense ratios.
How much does that save, though? Let’s say you invested $10,000 in each of those two funds. An expense ratio means that, in a given year, that percentage of the assets is being used to maintain the fund, employ the people running it, and so on.
So, at the end of 2009, a fund with a 0.06% expense ratio might have a face value of $10,000. Another fund with an expense ratio of 0.10% also has a face value of $10,000.
During the year 2010, the assets in those funds gain, let’s say, 2%. At the end of that year, the 0.06% expense ratio fund would have a balance somewhere close to $10,193.88 (depending, of course, when the expenses were taken out) and the 0.10% expense ratio fund would have a balance close to $10,189.80. This amounts to $4.08.
In other words, when the difference in expense ratios is small and your investment amount is relatively small, the amount of money you’re saving and losing is small.
However, let’s say you’re investing $1,000,000. The amount of money due to the difference in expense ratios is much closer to $408, and suddenly you’re talking about significant money.
Even with the $60,000 mentioned in the question, you’re talking about an approximate annual difference of $24.08, which may be less than the value they get from talking face-to-face with an advisor.
What about the difference in expense ratios? Let’s say that one fund has an expense ratio of 0.06% and the other has a ratio of 0.60%. You’re talking about a rough difference of $55.08 per year on an investment of $10,000, and $5,508 per year on an investment of $1,000,000. That’s a big difference.
Again, these types of comparisons only mean anything if you’re comparing very similar investments. The greater the difference between the investments, the less it means in the sense of a direct comparison.
As a rule of thumb, I usually subtract the expense ratio from the annual return numbers on any investment I look at. Although this isn’t anything like an exact comparison, it does give me an idea of how much I’m going to be hamstrung by their expense ratio over the years.
Usually, this leads me to investments with very low ratios. Usually, I find these types of investments at Vanguard or Fidelity, the two places you mention.
It is important to note that you shouldn’t just chase low expense ratios when you’re investing. Putting everything in the investment with the lowest expense ratio isn’t well diversified and will lose you money.
To put it simply, when you’re investing small amounts and the difference between the expenses in comparable investments is small, you’re talking about pennies (or a few dollars). But if either of those factors grows large, you’re quickly talking about dollars – and often lots of dollars.