Saturday, December 08, 2007

Invest in Low Cost Funds

I advocate investing in low cost funds, with an expense ratio of less than 0.7% for an equity fund.

The expense ratio of most funds in the market, including the financial adviser's fee to select and monitor the funds, is between 1.5% to 3%.

Here is the difference based on a net return (after deducting fee) of 5.5% for a low cost fund and 4.5% for a high cost fund.

`                   4.5%       5.5%    Diff\$5,000 a year       over 20 years     \$157,000  \$174,000   11%\$5,000 a yearover 30 years     \$305,000  \$362,000   19%\$50,000 singleover 10 years     \$77,600    \$85,400   10%\$50,000 singleover 20 years    \$121,000   \$146,000   21%`

Conclusion: The lower charge in a low cost fund can give a return of 10% to 21% higher on your investments.

Anonymous said...

I think it is unfair to draw your conclusion using this comparison.

The calculation is inappropriate.

You used simple compounding effect of 4.5%/5.5% on the principle + interest. Is this how in general funds/ETF work - on compounding interests?

You can based your CPF or savings account on this model. Returns by funds/stocks are virtual gains and they do not have compounding effects.

It is the same as saying I buy DBS stock at \$20 and since stock appreciated at 10% last year, I project my gains by compounding 10% on \$20 and if I hold on to DBS I would see DBS rise to \$135 in 20 years time.

Many of your previous posts with calculations fall into this category. Suggest you use the appropriate approximation tools for future illustrations.

Regards

Anonymous said...

Mr.Tan is using the most widely used method of predicting the future. The figure is an historical average or the expected return and this is the assumption that all returns will revert to its mean. He didn't use 20 or 40% which some funds returned in some years but their historical average.