Key ideas

1. The expense ratio is a yearly fee. A 0.05% fee costs $5 a year on $10,000. A 1% fee costs $100 on the same balance.
2. Small fee gaps add up over decades. At an assumed 7% before fees, 30 years of a 1% fee leaves $361,580, versus $442,364 at 0.05%.
3. Index funds can still lose money. They rise and fall with the market. Money you need within about 5 years belongs in savings, not stocks.

Vocabulary

Index fund

A mutual fund or ETF that tries to match a market index by holding the investments in it, rather than picking winners.

Stock

A small piece of ownership in a company. Its price rises and falls with how investors value the business.

Bond

A loan you make to a government or company. It pays you interest and returns your money on a set date, called the maturity date.

Expense ratio

The yearly fee a fund charges, shown as a percentage of what you have invested in it. It comes out of the fund automatically.

Assets

Things you own that have money value, like cash, savings, retirement accounts, investments, a home or a car.

Diversification

Spreading your money across many investments so that one bad company or sector does less damage to the whole.

Work it out

Priya, 30, invests $10,000 plus $300 a month for 30 years. She compares an index fund with a 0.05% fee and a fund whose managers pick stocks, at a 1% fee, assuming 7% before fees.

1. Total put in (either fund)
2. Return after a 0.05% fee
3. Return after a 1% fee
4. Balance after 30 years at 6.95%
5. Balance after 30 years at 6%
6. Cost of the higher fee

Check yourself

1. You have $20,000 in a fund with a 0.5% expense ratio. About how much does the fund take in fees this year?

   • A. $10
   • B. $100
   • C. $1,000

2. What does an index fund try to do?

   • A. Beat the market by picking winners
   • B. Match the return of a market index
   • C. Avoid any losses
   • D. Hold only one industry

3. Two funds track the same index. One charges 0.03% and the other 0.75%. Which is usually the better pick?

   • A. The 0.75% fund, because it costs more
   • B. Either, fees don't matter
   • C. The 0.03% fund

Your turn

Log in to your 401(k) or IRA and write down the expense ratio of every fund you own. If any charge more than 0.5%, find an index fund in the same account that tracks a similar market and compare its fee.