We suggested, based on academic evidence and the recommendation of people like Warren Buffett and Burton Malkiel, that participants focus on low expense funds that track the market.
The question then becomes what is the difference in terms of dollars? Suppose we assume that the 3 funds that we considered yesterday each achieve an average annualized return of 7.5% over the next 20 years. After subtracting fees what will be the impact?
A neat little calculator to do this calculation is available at .http://www.marketriders.com/ . At the bottom of the page click Mutual Fund Fee Calculator .
Click "Calculate My Fees" and you'll find that the annual fees are $74.00 and the value of the portfolio, under the assumption of a 7.5% return, after 20 years is $36,998.40.
Go through the same exercise and put in $10,000 for VIIIX , the low cost Vanguard fund that tracks the S&P 500. You'll find that the portfolio value is $42,320.73 - 14% higher!
Granted, it's not going to be this clean in the real world. The funds will have differing returns. The surest outcome is that VIIIX will perform close to the S&P 500. The difference between the 2 alternatives could in fact be greater than 14%.
But think of this- if the portfolio is $1.0 million and the difference is 14% then it equals a number of years of payouts. Typically a safe withdrawal amount if taken to be 4%. This would be $40,000/year from a $1.0 million portfolio. The 14% difference (after just 20 years!) amounts to 3.5 years of draw downs.
Disclosure: This post is for educational purposes only. Individuals should do their own research or consult fa professional before making investment decisions.