You can save a boatload of money if you decide to become an index fund investor. One of the first articles ever posted to YNAB’s blog was a reprint about index fund, or “passive” investing. If you’d like to read a truly excellent piece, head there.
It’s very debatable whether an actively managed mutual fund can even beat an index fund (2/3 don’t).
We’ll set that aside though, I just want to show you the measurable cost of actively managed funds.
According to Morningstar, the expense ratio for large blend index funds averages .59 percent. Also according to Morningstar, the expense ratio for large blend actively managed funds averages 1.22 percent. (The expense ratio is basically what you pay to be invested in that fund. You can consider it as an offset to your annual return).
Now…a mere .63 percent difference…that’s rather small don’t you think?
Until you introduce the power of compounding.
Let’s assume you contribute to your Roth IRA at $4,000 per year and do that diligently for 30 years. Let’s also assume the market gives you an 8% return, on average, for those 30 years. What type of impact will that .63% difference have on your nest egg?
If both funds performed the same (the actively managed fund consistently performed with the market, never beating it, but also never losing to it), your actively managed fund would be at $389,000.
Your index fund would be at $441,000.
To put this into a more chewable perspective, that’s a monthly savings of $144 (perspectives get a bit weird with compounding numbers, but you get my drift).
If you increase the length of investing time, or payments made, the difference only grows larger.
I know, there will always be some advisers out there touting their fund as the “next best thing”, but remember that 2/3 of actively managed funds don’t beat the market. You’re paying twice as much to have them do worse. Save your money (and time) and have a large chunk of your nest egg invested in index funds. If you still want to “dabble”, do it with an inconsequential portion of your nest egg that will give you the investing “rush” you’re looking for, but won’t set you back if you lose it all 🙂