Lower costs deliver a huge excess return over time
I wrote already several posts about ETF. ETFs are exchange traded index funds. They are not actively managed but they represent an index. Therefore ETFs are very cheaply priced and have much lower management fees compared to actively managed investment-funds.
An actively managed investment-fund tries to achieve an out-performance relative to the index due to his active management style. That should deserve a higher management-fee. But, as statistics show, most active funds are not able to beat the benchmark index over a long run.
That's why ETFs should be able to achieve the same investment performance before costs. But how do these management fees influence the performance? Due to the interest on interest the gap between high and low costs gets bigger and bigger over time! Have a look at the following model calculation, how much costs matters when investing!
Let's see, how an investor can save a lot of costs with a cheap ETF!
We do a easy model calculation based on the following assumptions:
investment period: 25 years
yearly market return: 5%
costs of an active fund: 2% p.a.
costs of an ETF: 0.5% p.a.
Costs take down the total performance over a long run. But this effect is much lower with an ETF - an ETF gets you more of the market return for your portfolio.
How you can see in the attached graph, the two lines have a wide gap. The upper line is the performance of the ETF, the lower line the performance of the active fund. Both invest in the same market with a market return of +5.0% p.a. But they have different costs (0.5% vs. 2.0%). In 25 years the ETF gets you nearly 200% performance, while the expensive fund is just above 100% performance. The difference is exactly 94.40%
This is a clear argument for ETFs and show how much investors should mind costs (custody, trading, management-fee, taxes, ...). They take down your market-return dramatically. By the way, an investment with 5% p.a. without any costs will get you an even higher performance in 25 years: +238%!