NGPF Activity Bank
Investing

CALCULATE: Investment Fees
Part I: Fees in 1st year
Suppose Adrian and Clemens each invest $10,000. Adrian invests in an actively managed mutual fund that has an annual expense ratio (a fee charged by the investment manager) of 1.3%. Clemens invests in a passively managed index fund linked to the S&P 500 that has an expense ratio of 0.2%. Both investments earn a 7% rate of return.

How much does each investor make on his investment with the 7% rate of return?

How much does Adrian pay in fees for his actively managed mutual fund?

How much does Clemens pay in fees for the index fund?

At the end of the year, what’s the total value (AFTER FEES) of Adrian’s mutual fund?

What’s the total value (AFTER FEES) of Clemens’s index fund?

How much more value does Clemens’s investment generate than Adrian’s in one year’s time?

Part II: Fees over many years
Let’s think of it another way so that we can see the impact of compounding on this investment. For simplicity’s sake, we’ll assume that Adrian’s rate of return is effectively 5.7% annually (7% - 1.3% fee) and Clemens’s rate is effectively 6.8% annually (7% - 0.2% fee). Each man contributes an additional $100/month into their investment account. Use the compound interest calculator to answer these questions. You can round to the nearest whole dollar and assume the investment compounds annually.

How much will Adrian have if he allows his investment to remain in the mutual fund for 10 years?

How much will Clemens have if he allows his investment to remain in the index fund for 10 years?

How much more value does Clemens’s investment generate than Adrian’s in 10 years’ time?

What about over 40 years’ time?

Part III: Summary
What’s the effect of choosing an actively managed fund over a passively managed one?

Give possible reasons, despite what you’ve seen in the exercise above, why some investors still opt for an actively managed fund.