Friday, January 25, 2008
The main point of our discussion was the different between Index Fund Fees and Mutual Fund Fees.
I compared S&P 500 (SPY) vs American Funds (AMRMX)
In this picture you will notice that both funds have many of the same stocks.
Holding the same stock should give you the same returns.
One reason Index Funds do better long-term is their lack of fees.
The Index Fund (SPY) has a fee called "Total Expense Ratio" of .08%.
Mutual Fund AMRMX has many other fees:
1) Total Expense Ratio - .55%
2) 12b-1 fee (Advertising) - .22%
3) Front Load (Sales charge) - 5.75%
4) Managers fee - .26%
5) End of year distribution - 1.29%
6) SAI fee (Statement of Additional Information) averages - 1.25%
Total if bought in 2007: 9.32%!!!
Total each year after: 2.28% minimum
What is the difference between a few percentage points in fees?
Diversify means putting your eggs in multiple baskets instead of all your eggs in one basket.
Instead of buying one stock you are buying one index fund that has many stocks.
First you become diversified by buying an Index Fund that owns a lot of different stocks.
Then you become more diversified by buying multiple Index Funds.
Later in life you become even more diversify by buying Multiple Index Funds, Bonds and other things.
Ric Edelman's Guide to Portfolio Selection (GPS) gives an example of what a well diversified portfolio looks like for someone who has over 75,000 to invest.
It's good to read through the questions.
You do not have to put your personal information in when they ask for it.
For the rest of us, just start with a few well diversified Index Funds.
SPY - US Large Cap - Index Fund
EFA - International Large Cap - Index Fund
EEM - Emerging Markets - Index Fund
Here is some very detailed information about Index Funds:
In conclusion: a Warren Buffett quote to backup our thinking:
Index funds are appropriate for inexperienced investors. In response to a question about why Buffett recommends index funds to investors, he said that for "a know-nothing investor, a low-cost index fund will beat professionally managed money." He also said he had a standing offer to anyone who could name 10 hedge funds that will beat a low-cost index fund. No one has taken him up on his offer.