Same Index Fund Different Returns —How Costs Reduce Investment Returns

While not apparent, two index mutual funds carrying the same name can yield different results due to investment costs. In one of my previous Forbes articles, Can Women Actually Retire Successfully with Index Investing in Gender Equality, I highlighted funds that tracked the MSCI KLD index.

That index outperformed the heralded S & P 500. Because those funds tracked the index that scored an A Grade in Gender Equality. The graphic below from the gender equality funds shows iShares’ version had the lowest expense ratio compared to the (Jackson National Life) JNL/Mellon version.

While the Jackson versions don’t have as long a track record, their returns can be extrapolated, because they replicate the index. That is one of the beauties of index fund comparisons. Note the index creator determines what companies are in the fund. The fund company determines what it will charge for replicating the index.

In How Costs Reduce Investment Returns Same Fund Different Returns, I explain that mutual funds have different expense ratios presented as share classes. In the case of the iShares KLD 400 investment, it is an ETF (exchange traded fund). This is simply a different way to get the benefit of a pooled investment, such as known as a mutual fund. Most importantly, ETFs don’t have share classes.

Investment expense ratios, share classes and distribution channels

According to Morningstar, A shares are usually the most cost-effective for long term investors who are using a commission-based broker to transact. Often there is an investment minimum of $2,500is $2,500 or less. Typically, the maximum initial expense (non-refundable deposit) is between 4% and 5.75%. You may have heard of this referred to as a front-end load.

There is an ongoing fee to the broker between 0 and .5%50 bps. This is known as a 12b-1 fee. A 12b-1 fee is a fee used to pay for a mutual fund’s distribution costs. It is often used as a commission to Registered Representatives (brokers) for selling the fund.

Large institutional buyers purchase the I share class (not to be confused with iShares). They have low if not the lowest expense ratios. Typically, the investment minimum is $250,000 or more. Investment advisor representatives and investment consultants use these and add their fee on top of these mutual funds.

The ETFs trade like a stock would trade. Channel partners will add a fee for their work on top of the cost of the ETF. Often that includes developing a portfolio and then determining which ETF should be included in the portfolio.

Get a fund fee x-ray

Expense ratios influence investment returns. The Financial Industry Regulatory Authority offers this FINRA Fund Analyzer to help evaluate the effects of expense ratios.

The fee analyzer starts by equalizing the initial investable amount, investment return expectation, and the inception date are all the same. This allows the focus to be on fees and not returns, which they address later. This example assumes $10,000 invested over 10 years, with a 5% expected investment return.

The chart shows that the investments with the lowest expense ratios have the highest return. Expense ratio represents the costs that the fund assesses to each channel. It would make sense that different channels have different costs. The highest account values are achieved with the iShares MSCI KLD 400 Social ETF.

The scenario producing the highest value may change depending on your entries and the actual holding period. The future values depicted are based on the 5% expected investment return and may not depict the results of actual returns.

While the analyzer default return assumption was 5%, this graphic from Gender Equality Funds shows the actual return over the last 15 years. When seen like this, the return differences don’t appear to be too dramatic.

If you missed Can Women Really Retire Comfortably with Index Investing In Gender Equality?, these returns beat the S&P 500 over the same time periods.

How much should costs affect your investment decision-making?

Cost is just one of the factors you should consider when investing. My discussion started with a desire to invest in index funds with A grades on gender equality. That may be the reason you choose an investment.

Based on your situation you may want to invest in the MSCI KLD 400 Social Index (or some other), but may not have a choice because of the investing platform you’re on. If this aligns with your values, congratulations!

The expense ratio should temper your return expectations. In this case, the difference isn’t huge. Hopefully, by investing more money or stretching out your time horizon you will still land on your savings goal.

I hope this article makes you a smarter investor in pursuit of your goals, aligned with your values.