Should you avoid mutual fund fees at all costs?

I work with a number of do-it-yourself clients that want to avoid fees.

Often, I will recommend DIY investors who may have good low-cost large cap stock options in their workplace plans use complementary investments in their IRAs, Roth IRAs, and brokerage accounts.

Many times, these complements are niche areas: International small cap, global real estate, and emerging markets to name just a few.

The firm I find DIY investors can access the most asset class options in low-cost passive funds is The Vanguard Group. One Vanguard fund that often mesh well with retirement plan offerings for an investors outside funds is the FTSE All-World ex-US Small-Cap Index (VFSVX). The fund charges a purchase fee and redemption fee of 0.50%.

Investors often push back on paying this fee. They’ve been told to “never” pay a purchase fee.

I agree that DIY investors are right to be skeptical of paying sales commissions to brokers, also known as purchase or redemption loads. However, there are differences between the fees commonly discussed in articles, and those charged here, and disadvantages to your portfolio if an investor were to rule this fund out due to the charges.

Rather than compensating brokers with the fee, Vanguard is protecting long-term investors from bearing the costs associated with investing in markets that are more difficult to trade in. Principal of Vanguard’s Public Relations John S. Woerth explains that the fees “are not loads. They are paid to the fund to defray transaction costs, which tend to be higher in foreign and more illiquid markets. If the fund did not charge a fee, those transactions costs would be borne by all holders of the fund. The fees properly and fairly allocate those costs to the shareholders who are generating them.”

In other words, short-term traders cannot pass on the costs of trading in and out of a portfolio to the detriment of long-term investors.

Woerth also notes that Vanguard has a history of changing fees going back to 1994 when they introduced the Emerging Markets Stock Index Fund VEMAX. Today, due to the growth of the fund, and growth of emerging markets investments, the fund no longer charges these fees.

It’s worth noting the benefits of diversification that these funds can provide. In reviewing the performance of VFSVX to the FTSE All-World ex-US Index, which is the large-cap index fund with no purchase fees. If by avoiding the fees you chose to use only the large cap fund, your performance would have been less by 13 percentage points in 2010, 0.5 percentage points in 2012, and 2 percentage points in 2013. You would have trailed by 5.5 percentage points in 2011, but a diversified investor would hold allocations to both small and large.

Can an investor avoid these fees by purchasing the exchange-traded fund version of VFSVX? VSS is the ticker for the ETF fund that at Vanguard will trade for no commissions, and also has a lower expense ratio.

Isn’t this then a no-brainer option?

Not necessarily.

First, ETFs, and specifically those in these supporting roles, may trade at a premium or discount to their underlying value, where mutual funds do not. As of 9/18, Vanguard’s website reports the premium to purchase VSS is $1.37 to the underlying net asset value of $100.27, or 1.36% above the value. Your “load” for purchasing this on the market is nearly 3x at present than the mutual fund purchase fee, and this will increase, or decrease (which is harmful at the time of sale) based on demand.

Next , ETFs require trading on the market, which means setting your own price. Another consideration overlooked is when mixing ETFs with funds,there are additional potential costs as I outlined in this past blog.

My advice to DIY investors is try to be fee-conscious without being fee-absolute.

The preceding blog was originally published by Forbes. To view the original blog please visit our blog at Forbes.


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