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Jul 2 / Carrie Leach

The Tyranny of Compounding Fees: Are Mutual Funds Bleeding Retirement Accounts Dry?

stu neufeld

Dr. Neufeld (pictured) presented this conference paper at the Gerontological Society of America annual conference. Using historical data, this paper aims to document the effect of several levels of mutual fund fees and expenses on investment returns. Preliminary results suggest that over typical working careers (30-40 years), the financial services industry captures 70-80% of investment gains, leaving the individual investor with only 20-30%.

Executive Summary

  • Investments in retirement accounts are plagued by poor returns. An important factor is that, in aggregate, returns of actively managed equity mutual funds trail those of broad market indices.
  • This paper partitions the real total return of the S&P 500 into: (1) return to mutual fund investors and (2) return to the financial services industry. The author calculates these shares for all 10-, 20-, 30-, 40-, and 50-year investment periods using data from January 1871 to June 2011.
  • The financial services industry share of market returns increases with the length of investment period. For annual performance lags of 250 basis points (bps), the industry share over 10 years is about 46 percent on average; over 50 years it increases to 74 percent.
  • Smaller degrees of underperformance increase investor shares substantially: 50-bp lags result in an average investor share of 90 percent for 10-year investment periods and 77 percent after 50 years.
  • The shares of market returns to investors and the financial services industry are highly variable for shorter investment periods, but this variability declines as the investment period increases.
  • A 100-bp annual lag in performance over 50 years would reduce retirement assets currently held in equities by about $28 trillion (inflation adjusted), an amount almost twice that of the entire U.S. national debt as it currently stands, assuming average market returns.
  • The author recommends that pension plan fiduciaries be required to select default investments with a management expense ratio (MER) as low as possible, ideally no greater than 10 bps. Also, financial advisers should direct client funds to similarly low-cost investment vehicles.

To download the full report click here.

Dr. Neufeld is an IOG assistant professor, jointly appointed with the department of anthropology. He has a doctorate in mathematics and his research focuses on retirement security, risk, and financial decision making. To learn more about Dr. Neufeld and his research please visit his profile page here.

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  1. Carrie Leach / Jul 3 2013

    Larysa Blysniuk shared this special that aired on PBS that really investigate the implications of compounding fees

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