Mutual Fund Costs: Saving Money While Making Money

Most of us use mutual funds for our investment portfolios. We get professional management and diversification that way. If we had millions of dollars, we could afford private portfolio management in order to obtain those important benefits.

Either way, there are costs. Some funds, or managers, are more expensive than others. But funds and managers generate unique investment performance, and they establish unique track records. So, cost alone is not the right factor to consider when selecting our investments.

It really should be about "cost-justification". I've said this here before, but I just read yet another magazine article that I think sends the wrong message: "Shop around for inexpensive investment options in order to maximize returns."

That's dubious advice. When put that simply, it will lead folks to use only the cheapest funds.

Let's compare two very popular mutual funds and test that advice: PIMCO Total Return C (PTTCX) vs. Vanguard Total Bond Market Index (VBMFX), both of which are bond-oriented mutual funds intended to provide broad exposure to income-producing, low-volatility fixed-income investments. Neither charges a front-end sales "load", and they have almost the same amount of volatility/risk.

PTTCX has a pretty high "expense ratio" of 1.65%. This would make Suze Orman pretty emotional.

VBMFX has a very low "expense ratio" of .22%. This would make Suze Orman pretty happy.

PTTCX vs. VBMFX over the past 10 years? 6.46% per year to 6.10% per year. PTTCX wins!

Over the past five years? 6.29% to 5.55%, and PTTCX wins again.

Three years? 9.77% to 7.45%. PTTCX, again.

The last 12 months? 10.82% to 8.00%. PTTCX

And how about the last month? 1.33% to .84%. Yes, PTTCX won again.

(all of those returns are inclusive of the "expense ratio", or "net of fees")

That's a great example of "cost-justification vs. cost alone". And something else to consider is this: VBMFX is an index fund that must stay fully-invested all the time in a specific group of investments, while PTTCX can keep money on the sidelines or move around within the fixed-income arena to avoid problems or take advantage of opportunities. While that would be a problem if PTTCX "bets wrong", that fund has an extremely long and successful track record.

Now, this is the rare case, but don't let its rarity deter you. You should pursue the best product available. Sure, about 80% of mutual funds fail to beat their benchmarks, but you can find out on your own which ones do beat their benchmarks.

Or, you can hire a financial advisor to figure that our for you. Not all of us are diligent about it, but some of us really are, and it's to your benefit.