Why Low-Cost Funds Fuel Nest Eggs

The cheap fees pioneered by Vanguard decades ago are a boon to today’s retirement savers

Allan Roth,

AARP

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Published April 29, 2024

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If you’re saving for retirement, you’re probably familiar with some of today’s giant fund families. Vanguard, Fidelity, BlackRock and the like offer investors a variety of mutual funds and exchange-traded funds (ETFs) from which to choose — and they’re cheap. Last year, the weighted average annual expense ratio was just 0.42 percent for stock funds and 0.37 percent for bond funds, according to the Investment Company Institute. Index funds, the popular investments that passively track a market index, had an average fee of only 0.12 percent, according to Morningstar.

But it wasn’t always this way. In 1990, the average stock fund charged 1.81 percent, while the average bond fund charged 1.71 percent. If that weren’t bad enough, most funds levied an additional sales load just to buy the funds. All those fees could substantially cut your returns over time.

For example, consider two mutual funds: One that charges 0.3 percent a year and one that a charges 1.5 percent in fees every year. Both funds earn 7 percent a year on their investments. The low-cost fund would return 6.7 percent a year to investors after fees, while the other would return 5.5 percent a year to investors. The difference on a $10,000 investment over 20 years? Investors in the low-cost fund would have $36,580 in their nest eggs, while the high-cost fund investor would have $29,180 — a difference of $7,400.

Why funds fees are lower today

Things have changed dramatically, I’m happy to say. What caused fees to plummet? The Securities and Exchange Commission didn’t mandate mutual funds to lower costs. It was the late John C. Bogle, the founder of Vanguard and the so-called father of the index mutual fund, who led the charge. In 1976, he launched the first mutual fund to track the S&P 500 index, made up of the stocks of 500 of the largest companies traded in the U.S. The funds he launched also charged no sales loads. While Bogle gave investors access to cheaper funds, it was investors who taught the industry a lesson by voting with their wallets for lower costs.

I bought my first index funds in the late 1980s. Though Vanguard was one of the five largest fund families at the time, it didn’t market much. Fidelity and Dreyfus did, however, and those were the first two S&P 500 index funds I purchased.

I decided to take a look at the top 10 fund families in 1989 compared with today. The 1989 numbers came from a presentation Bogle made roughly a decade ago, while investment research firm Morningstar is the source of the current data.

Today, Vanguard is nearly the same size as the next three largest fund families combined. Note that these are assets in mutual funds and exchange-traded funds, and doesn’t include other assets, such as in individual stocks or private investments. Gone from this list are DWS, Dreyfus, Federated, Morgan Stanley and Putnam. Franklin Templeton is only in the top 10 because it bought Putnam earlier this year. But Fidelity and BlackRock remained in the top three.

I asked Amy Arnott, a portfolio strategist at Morningstar, to sum up the change over the last 35 years: “The evolving list of dominant fund companies reflects some powerful positive trends over the past 35 years,” she says. “The big have gotten bigger, the strong have gotten stronger and trillions of assets have flowed into lower-cost funds.”

Of course, this also means those fund families that put their own profits ahead of investors lost market share or became extinct. This can best be illustrated by my first two index funds: Fidelity and Dreyfus. Fidelity lowered fees to match and then best Vanguard in some funds. Dreyfus did not and, outside of money market funds, faded away. Dreyfus was bought by Mellon Bank, which then merged with Bank of New York. Today, the combined funds of BNY Mellon are only $55.7 billion, barely larger than Dreyfus was 35 years ago. Investors have pulled money out of BNY Mellon funds every year over the past decade, according to Morningstar.

Many of the current largest funds are known for low fees with either indexing or other passive approaches. The American Funds are perhaps the largest outlier — they were not in the top 10 35 years ago but stand at number four today. American still has funds with sales loads. Even so, time may have caught up as Morningstar shows investors yanked $135.3 billion out of the fund family since 2022.

Saving for retirement? Think cheap

John Bogle gave investors access to low-cost funds. Morningstar and others measured performance and showed the impact of fees on returns. Then, many in the media picked up on the message and investors voted with their money – yanking from expensive funds in favor of lower fees and parent fund families that placed investor returns over short-term profits.

Investors taught the fund industry to consider their needs. We did this by rewarding fund families that placed the highest priority on investors with trillions of dollars, and by punishing companies that didn’t.

Take a look at the cost of owning each of the funds in your 401(k), IRA or other investment accounts. You can find the expense ratios on fund company websites, or check Morningstar.com or a similar site. If the expense ratio of any fund is more than 0.2 percent annually, you should consider switching to a cheaper fund with a comparable objective and performance history.

Don’t move to lower cost funds to punish a fund family. Do it because you need the money in your nest egg more than the financial services industry.

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Allan Roth is a practicing financial planner who has taught finance and behavioral finance at three universities and has written for national publications including The Wall Street Journal.