Matter/scatter, part 6: Expense ratios

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Matter/scatter, part 6: Expense ratios

Post by nisiprius »

Part 1: Introduction, Part 2: Bond fund choices,, Part 3, International bonds, Part 4: Bond allocation. Part 5: International stocks Brief notes: 1) In these Monte Carlo simulations, the return for a given month is varied by randomly choosing the actual historical return or the actual historic return for an adjacent month. 2) They show the final value from $100 monthly contributions made over the whole time period. 4) Green and red crosses mark actual historical values. 5) Green and red bars show the 10% percentile, median, and 90% percentile of the range of outcomes. 5) The actual data source is, Backtest Portfolio, Monthly Returns; this is used as calculation input; and no PV content or numeric values are directly reproduced.

John C. Bogle has talked about the "CMH," the "cost matters hypothesis." Yes, it does, but...

I was planning to post this today anyway, but the news of Fidelity's "ZERO funds" makes it even more timely. Before I show the results, I want to put a bit of spin on them: a small dollar difference that is all but guaranteed is different in kind from a small dollar difference that is just empirical past history, or educated guesswork.

Because of large differences in the number of years of available data, these charts can't be compared directly against each other.

VFINX, the Vanguard 500 Index Fund, currently has an expense ratio of 0.14%. The Invesco S&P 500 Index Fund, Class A, SPIAX, currently has an expense ratio of 0.58%.

Here are the results of a 60/40 balanced portfolio. In order not to be limited by the time range of Total Bond, in this and the remaining comparisons, the 40% bonds is the Fidelity Investment-Grade Bond Fund, FBNDX. For the 60% stocks, we use the low-expense VFINX (green) and compare it to the pretty-high-expense-for-an-index-fund SPIAX.


Here is VFINX versus the Rydex S&P 500 Fund Class A, RYSOX, again as the 60% stock component of a 60/40 portfolio. RYSOX has been called the "world's worst index fund," with an incredible expense ratio of 1.57%. We have only twelve years to look at.


Even here, the difference in median final value is $2,000, while the range of outcomes in the simulation covers a span of over $7,000. I have to say, though, that given that the results of expense differences is virtually guaranteed, this looks like it really matters.

When my employer had a Fidelity-managed 401(k) plan, the only bond index fund option was the Fidelity US Bond Index Fund, which at that time had an expense ratio of something like 0.50%, while Vanguard Total Bond's was less than 0.20%. I found this annoying but I used it anyway. Circa 2011 they cut the expense ratio to something close to Vanguard's, and currently it is less than Vanguard's. We sometimes read that expense ratios are even more critical in a bond fund than a stock fund because they are coming out of a smaller expected return. If a stock fund is returning 10% before expenses, an 0.50% expense ratio bleeding you of 1/20th of your returns. If a bond fund is returning 2% before expenses, the same 0.50% expense ratio is bleeding you of 1/4th of your returns.

In any case, here's the difference between a 60/40 portfolio in which the 60% stocks is VFINX, and the bond allocation is either the low-expense VBMFX or the somewhat-higher-expense FBIDX.

Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
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