Why do we pay ER fees? [Expense Ratio]

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
investor1
Posts: 1052
Joined: Thu Mar 15, 2012 8:15 pm

Why do we pay ER fees? [Expense Ratio]

Post by investor1 »

Why do investors seem perfectly happy to pay expense ratio fees rather than load fees?

Don't get me wrong, I understand load fees tend to raise a red flag in today's society. However, I think that's more of a result of having to pay these fees in addition to an ER. The fact that someone is adding a fee tends to mean the investor can get a better deal elsewhere.

However, load fees are a one time deal whereas expense ratios are an annual fee. Also, load fees are charged on the amount of the transaction whereas expense ratios are charged on the amount of the fund held in the account. It seems like getting rid of expense ratios in favor of load fees would provide a more clear understanding to the average investor regarding the cost of investing. From there, it would seem to be easier for the free market to kick in and drive those fees down due to demand and competition.

I guess I could see how switching to a model where the transaction is paid for rather than holding the assets would deter day traders, but I wouldn't think very many people on this board would be all that concerned with that.

Why aren't investors, particuraly Bogleheads, demanding the industry switch from expense ratios to load fees?
sport
Posts: 9544
Joined: Tue Feb 27, 2007 3:26 pm
Location: Cleveland, OH

Re: Why do we pay ER fees?

Post by sport »

A load fee system would not be fair. The shorter term investor would be subsidizing the longer term investors. By having a small annual fee, the costs are fairly borne by those who generate the costs.
Jeff
Topic Author
investor1
Posts: 1052
Joined: Thu Mar 15, 2012 8:15 pm

Re: Why do we pay ER fees?

Post by investor1 »

Please forgive me if I am being thick, but how so? It would seem the current model has the buy-and-hold crowd subsidizing the day traders.
User avatar
in_reality
Posts: 4529
Joined: Fri Jul 12, 2013 6:13 am

Re: Why do we pay ER fees?

Post by in_reality »

investor1 wrote: Why aren't investors, particuraly Bogleheads, demanding the industry switch from expense ratios to load fees?
Because some love to do tax-loss harvesting when they can!

Anyway, it's not practical. How do you know how long I will hold the fund for, so how much do you know how much to charge me? If my family holds the stocks for 3 generations, does your initial load fee cover the ongoing management costs?
ASUGrad
Posts: 259
Joined: Sun Oct 20, 2013 8:09 pm

Re: Why do we pay ER fees?

Post by ASUGrad »

I don't see how it would make things cheaper. Vanguard funds run at cost. So the ER you pay is what it costs VG to run the fund, and they are VERY low. To prevent day traders the funds have restrictions on moving money in after moving it out. If VG switched to a load instead of expense ratio then the 2+ trillion people already have invested wouldn't be expensed ever again. How much would they have to charge the billions that come in each year to pay for the 2+ trillion already being managed(passively)?

This would also cause a HUGE problem during down markets. What happens when more money is going out then in? Even disciplined index investors aren't always perfect. What would a fund company do if it had no revenue during a year like 2008?

It wouldn't be good for investors, and it would be very illogical for fund companies to do. It also puts a lot more pressure on funds & advisors to encourage trading in and out rather than staying the course. Fund companies would have huge incentive to constantly bring in more money. They already do, but amplify that 100 times.
Topic Author
investor1
Posts: 1052
Joined: Thu Mar 15, 2012 8:15 pm

Re: Why do we pay ER fees?

Post by investor1 »

Thank you all for your responses.
in_reality wrote:Anyway, it's not practical. How do you know how long I will hold the fund for, so how much do you know how much to charge me? If my family holds the stocks for 3 generations, does your initial load fee cover the ongoing management costs?
Ah, that makes sense.
User avatar
arcticpineapplecorp.
Posts: 6207
Joined: Tue Mar 06, 2012 9:22 pm

Re: Why do we pay ER fees?

Post by arcticpineapplecorp. »

I tried to run the math (tell me if I'm wrong)...knowing that a load often is 5.75%, wouldn't it take 112 years to pay an equivalent cost at an E.R. of 0.05% (for US total stock market index fund for instance)?

=FV(.0005,112,0,-100)
=PV(.0005,112,0,-105.76)

I'd rather take 112 years to pay $5.76 for every $100 invested, rather than paying it EVERY time I bought a load fund at 5.75%.

Or another way of saying it is, I'd much rather pay $0.05 (every year) for every $100 invested instead of $5.75 for every $100 invested.

Is that right?
It's "Stay" the course, not Stray the Course. Buy and Hold works. You should really try it sometime. Get a plan: www.bogleheads.org/wiki/Investment_policy_statement
pkcrafter
Posts: 14332
Joined: Sun Mar 04, 2007 12:19 pm
Location: CA
Contact:

Re: Why do we pay ER fees?

Post by pkcrafter »

It's not load fees or expense ratios: it's load fees and expense ratios. Loads do not go toward the management of the fund, they go to the guy who sold it. It's a commission. For A shares, the commission is taken before the remainder of your money is invested. Don't get me wrong, I've love to have a fund with no load and no ER. :happy

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.
sport
Posts: 9544
Joined: Tue Feb 27, 2007 3:26 pm
Location: Cleveland, OH

Re: Why do we pay ER fees?

Post by sport »

pkcrafter wrote:Don't get me wrong, I've love to have a fund with no load and no ER. :happy
I believe there are funds like that. They are run by Mr. Ponzi.
Jeff
User avatar
Kosmo
Posts: 1303
Joined: Wed Sep 05, 2012 11:54 am
Location: Philadelphia

Re: Why do we pay ER fees?

Post by Kosmo »

I would not like it if every paycheck 5.75% of my 401k contribution went to paying a front load. If expense ratios were significantly higher (perhaps in a world without Vanguard, where 1% ER was cheap) then out would be a different story as the expected holding time of the security would make one option clearly better.
Topic Author
investor1
Posts: 1052
Joined: Thu Mar 15, 2012 8:15 pm

Re: Why do we pay ER fees?

Post by investor1 »

To be clear, I wasn't asking if you would rather pay the typical load fee or the lowest ER fee. My question was about leveraging load fees to cover the cost of the investment rather than using ER fees for that purpose and using load fees to pay the reseller.
Stonebr
Posts: 1472
Joined: Wed Jan 21, 2009 11:19 am
Location: Maine

Re: Why do we pay ER fees?

Post by Stonebr »

How would a fund know what their costs are going to be 10 years from now? Suppose there's changes in securities laws that require fund companies to hire a bunch of attorneys for something that wasn't anticipated in the pricing model you suggest, or invest in new technology that didn't exist when you paid your load? What happens then?
"have more than thou showest, | speak less than thou knowest" -- The Fool in King Lear
adam1712
Posts: 504
Joined: Fri Jun 01, 2007 5:21 pm

Re: Why do we pay ER fees?

Post by adam1712 »

I'd be worried about service suffering since a company has no incentive to keep you happy (especially long term investors) when they've already got the load. You're either stuck or have to pay another load.

Also, if a company is struggling to attract new investments, things could be on a downward spiral very quickly. Seems like it could bring less stability to fund companies.
User avatar
pjstack
Posts: 1308
Joined: Tue Feb 20, 2007 5:03 am
Location: Harbor City, CA

Re: Why do we pay ER fees?

Post by pjstack »

I really don't understand the original question.

ER stands for Expense Ratio, and running a fund (or a lemonade stand, for that matter) generates expenses. People have to be paid, equipment, computers, etc. have to be purchased/maintained, and so on.

You can't run a business without expenses. How could you "eliminate" an expense ratio?
pjstack
User avatar
LadyGeek
Site Admin
Posts: 66402
Joined: Sat Dec 20, 2008 5:34 pm
Location: Philadelphia
Contact:

Re: Why do we pay ER fees?

Post by LadyGeek »

The wiki has some background info: Expense ratios
Wiki To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.
User avatar
JoMoney
Posts: 9774
Joined: Tue Jul 23, 2013 5:31 am

Re: Why do we pay ER fees?

Post by JoMoney »

I would build a diversified portfolio of individual stocks rather than pay higher ER's. But when considering over the course of my life I'll be either making new contributions or making regular withdrawals, ER's < .10% seem pretty trivial relative to ongoing brokerage fees and other hassles related to managing a large portfolio of individual stocks. If you look even further at the benefits at Vanguard (including having 100% of the securities lending income given back to the fund) the actual cost may even be lower than the stated ER.
https://personal.vanguard.com/funds/rep ... 2210085756
Image
Morningstar Chart
Image
I'm not sure how consistent this benefit will be, but in the institutional class funds like VIIIX with its .02% ER the fund has been able to consistently perform better than the index it tracks.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
freddie
Posts: 920
Joined: Sat Feb 08, 2014 11:06 pm

Re: Why do we pay ER fees?

Post by freddie »

You might not be able to eliminate it but you could probably reduce it. The personal that sticks 100k in and doesn't do anything for 20 years doesn't cost the fund as much as the person that invests 1k/month for 10 years and then takes out 1k/month for another 10. Now I wouldn't be surprised if that number is pretty close to zero. After all a lot of it is just messing around with bits on a computer (you sell 10k and someone else buys 10k means you don't need to sell any shares) and doing anything that discourages people from giving you money (i.e. I don't have money in the international small cap because of those fees) might be a poor business choice.

pjstack wrote:I really don't understand the original question.

ER stands for Expense Ratio, and running a fund (or a lemonade stand, for that matter) generates expenses. People have to be paid, equipment, computers, etc. have to be purchased/maintained, and so on.

You can't run a business without expenses. How could you "eliminate" an expense ratio?
User avatar
BL
Posts: 9521
Joined: Sun Mar 01, 2009 2:28 pm

Re: Why do we pay ER fees?

Post by BL »

LadyGeek wrote:The wiki has some background info: Expense ratios
A 12b-1 fee has also been used as a hidden way to pay brokers for using the fund. The SEC has limited the 12b-1 fee to 1% annually with maximum of 0.25% going to brokers.
Here the ER is increased to pay brokers as well. I believe some brokers are getting income from both loads and ERs on the same funds.
JW-Retired
Posts: 7184
Joined: Sun Dec 16, 2007 12:25 pm

Re: Why do we pay ER fees?

Post by JW-Retired »

investor1 wrote:To be clear, I wasn't asking if you would rather pay the typical load fee or the lowest ER fee. My question was about leveraging load fees to cover the cost of the investment rather than using ER fees for that purpose and using load fees to pay the reseller.
The first thing I learned from a book about mutual funds investing back in about 1970-something was "never pay a load". Sure, your high cost fund company salesman can show you that their "class A" load funds will actually cost you less than their higher ER "class B or C" funds, providing you hold them for a decade or two. So what? IMO, you will come to your senses about the wisdom of doing high cost fund investing and want out long before that crossover occurs. Holding either class for a long time is an expense disaster.

You can't get the load back but you can put a stop to the slower high ER bleeding when you decide to. You need to preserve that option.
JW
Retired at Last
User avatar
JamesSFO
Posts: 3241
Joined: Thu Apr 26, 2012 10:16 pm

Re: Why do we pay ER fees?

Post by JamesSFO »

investor1 wrote:To be clear, I wasn't asking if you would rather pay the typical load fee or the lowest ER fee. My question was about leveraging load fees to cover the cost of the investment rather than using ER fees for that purpose and using load fees to pay the reseller.
Ok, so since one of the things Bogleheads tend to believe is that "costs matter" and one of the reasons Vanguard (VG) is particularly liked is because services are delivered "at cost", it strikes me that any approach that attempts to extract the costs upfront will inherently not be at cost, but rather either be a "windfall" for long holders or a high "tax" on short holders.

Further, the "load" approach would suffer greatly if there were regulatory changes, e.g. 10 years in Congress or the SEC passes a law mandating certain services and now what do you do? Charge another 1 time load?

This anchors back to wanting to keep costs low and purchase/use funds "at cost" when possible. The load approach doesn't allow that ultimately and thus isn't used for that.
User avatar
SSSS
Posts: 1893
Joined: Fri Jun 18, 2010 11:50 am

Re: Why do we pay ER fees?

Post by SSSS »

jsl11 wrote:
pkcrafter wrote:Don't get me wrong, I've love to have a fund with no load and no ER. :happy
I believe there are funds like that. They are run by Mr. Ponzi.
A couple years ago I saw an actively managed fund that was offering a negative expense ratio to try to rebuild their asset base after a lot of investors left due to underperformance.
User avatar
Regal 56
Posts: 460
Joined: Thu May 24, 2007 5:47 pm
Location: South Euclid, OH
Contact:

Re: Why do we pay ER fees?

Post by Regal 56 »

SSSS wrote:A couple years ago I saw an actively managed fund that was offering a negative expense ratio to try to rebuild their asset base after a lot of investors left due to underperformance.
To paraphrase Groucho Marx, I'd never own a fund that would pay to have me as a member.
Dandy
Posts: 6355
Joined: Sun Apr 25, 2010 7:42 pm

Re: Why do we pay ER fees? [Expense Ratio]

Post by Dandy »

Funds that charge a load also charge expenses in an expense ratio. In general, the load goes to the sales organization, any 12b-1 fee for advertising and the expense ratio for ongoing expenses/profits. Often the expense ratio of load funds are also very high.
Post Reply