Fees in a Mutual Fund Prospectus: Three Ways A Prospectus Deceives

(part 3 of 3)

Last time we looked at the list of fees within the “Fees and Expenses” section of a prospectus. There’s another misleading chart in this part of the prospectus. It’s the ten year fee table that purports to show the expenses on a $10,000 investment. You’ll find it in all mutual fund prospectuses. This is what happens in a chart called “Expenses on a $10,000 Investment.”

It’s easy to overlook the impact of fees when they’re divorced from earnings.


This chart shows fees taken out at the end of 1, 3, 5, and 10 year periods. It is required by the SEC. Click here to see the SEC’s tips for reading reading a prospectus.

Here’s an example of this chart based on 5% earnings and a 1% fee:

“Expenses on a $10,000 investment”* (See how amounts are computed below.)

1 year    3 years    5 years    10 years
$105     $344        $625       $1,557

A compounded 1% fee on $10,000 comes to a little over $100. That seems so little compared to $10,000. But that isn’t anywhere close to the actual amount you will pay each year.

Your “actual” fee deduction is the difference between the amount your money makes and how much is taken out for fees during that same time period.

In the SEC ten year fee table example, that’s (5% of $10,000) or $500 minus (1% of $10,000) or $100. That’s $500 minus $100 for the first year.

$100 divided by $500 is 20%, not 1% in fees on your earnings each year.

Your compounded earnings go up by over 5% each year, but you are losing 20% of that amount each year because the annual fees you’re charged are on your total investment. Each year you’ll lose one-fifth of your compounded earnings!

Here’s another way to look at this. Over a period of ten years, assuming your investment earns zero, you’ll lose1% per year in fees from your initial investment of $10,000. That’a 10% or $1,000! Over fifty years, you’ll lose 50 percent of your initial investment to fees. That’s $5,000!

You lose a such large chunk of your investment over the long term because the 1% fee is charged over and over again every year against the same total investment you made at the beginning, i.e., the $10,000.

In order to make anything at all from your investment, your real earnings must make up for the 20% fee that’s deducted annually from the total of your earnings and the compound interest on those earnings. This is why the chart below shows a loss of so much at the end of a period of 51 years.

Thanks to the magic of compounding and the sleight of hand that takes fee deductions out of the entire mutual fund so that they’re invisible to you, after 51 years you’ll pay fees equal to 40% of your initial investment and its total earnings.  After  51 years your $10,000 investment would earn over $120,000. But when a 1% fee is taken out each year, your return will only be $72,000, or 60% of what your money actually earned. You’ll pay over $48,000 in fees at 1%.

Looking at the ten year fee table in a prospectus you’d never guess this!

Why doesn’t the ten year fee table in a prospectus show this consequence of paying 1% in fees? Because the SEC-mandated fee chart is not intended to show you the actual amounts fees will cost you. It is intended merely to let you compare certain types of fees for one mutual fund with the same types of fees at another mutual fund.

What should be in a prospectus?

The SEC’s required fee chart is disingenuous. A prospectus should show the actual cost of fees charged on mutual fund earnings compounded over time.

The difference in expectations about fees versus their reality is outrageous! Many mutual fund investors wind up with a vague feeling after years of investing that something wasn’t right. They didn’t get what they thought they were going to get. Now you know why.

I think prospectuses should be required to include a chart showing both fees and earnings, like the one below. And I feel 1% is way too much! Wouldn’t you agree?

CHART:  Mutual Fund Fees and Earnings over 51 Years at 5%

2% Fee 1% Fee No Fee
Start $10,000.00 $10,000.00 $10,000.00
Year 1 $10,290.00 $10,395.00 $10,500.00
Year 2 $10,588.41 $10,805.60 $11,025.00
Year 3 $10,895.47 $11,232.42 $11,576.25
Year 4 $11,211.44 $11,676.10 $12,155.06
Year 5 $11,536.57 $12,137.31 $12,762.82
Year 6 $11,871.14 $12,616.73 $13,400.96
Year 7 $12,215.40 $13,115.10 $14,071.00
Year 8 $12,569.64 $13,633.14 $14,774.55
Year 9 $12,934.16 $14,171.65 $15,513.28
Year 10 $13,309.26 $14,731.43 $16,288.95
Year 11 $13,695.22 $15,313.32 $17,103.39
Year 12 $14,092.38 $15,918.20 $17,958.56
Year 13 $14,501.06 $16,546.97 $18,856.49
Year 14 $14,921.59 $17,200.57 $19,799.32
Year 15 $15,354.32 $17,880.00 $20,789.28
Year 16 $15,799.60 $18,586.26 $21,828.75
Year 17 $16,257.78 $19,320.41 $22,920.18
Year 18 $16,729.26 $20,083.57 $24,066.19
Year 19 $17,214.41 $20,876.87 $25,269.50
Year 20 $17,713.63 $21,701.51 $26,532.98
Year 21 $18,227.32 $22,558.72 $27,859.63
Year 22 $18,755.91 $23,449.78 $29,252.61
Year 23 $19,299.84 $24,376.05 $30,715.24
Year 24 $19,859.53 $25,338.91 $32,251.00
Year 25 $20,435.46 $26,339.79 $33,863.55
Year 26 $21,028.09 $27,380.21 $35,556.73
Year 27 $21,637.90 $28,461.73 $37,334.56
Year 28 $22,265.40 $29,585.97 $39,201.29
Year 29 $22,911.10 $30,754.62 $41,161.36
Year 30 $23,575.52 $31,969.42 $43,219.42
Year 31 $24,259.21 $33,232.22 $45,380.39
Year 32 $24,962.73 $34,544.89 $47,649.41
Year 33 $25,686.64 $35,909.41 $50,031.89
Year 34 $26,431.56 $37,327.83 $52,533.48
Year 35 $27,198.07 $38,802.28 $55,160.15
Year 36 $27,986.82 $40,334.97 $57,918.16
Year 37 $28,798.43 $41,928.20 $60,814.07
Year 38 $29,633.59 $43,584.37 $63,854.77
Year 39 $30,492.96 $45,305.95 $67,047.51
Year 40 $31,377.26 $47,095.54 $70,399.89
Year 41 $32,287.20 $48,955.81 $73,919.88
Year 42 $33,223.53 $50,889.56 $77,615.88
Year 43 $34,187.01 $52,899.70 $81,496.67
Year 44 $35,178.43 $54,989.24 $85,571.50
Year 45 $36,198.61 $57,161.32 $89,850.08
Year 46 $37,248.37 $59,419.19 $94,342.58
Year 47 $38,328.57 $61,766.25 $99,059.71
Year 48 $39,440.10 $64,206.01 $104,012.70
Year 49 $40,583.86 $66,742.15 $109,213.33
Year 50 $41,760.79 $69,378.46 $114,674.00
Total after Year 51 $42,971.86 $72,118.91 $120,407.70
Total gain 36% Return 60% Return 100% Return
% lost from fees (64% in fees) (40% in fees) (0% in fees)

* To see the the actual cost of a 1% fee on $10,000 at 5% over a ten year period, take the amount over $10,000 in the “no fee” column and subtract the amount over $10,000 in the 1% fee column for that year

For example, for Year 1
$500 – $395 = $105.

For Year 5
$2,762 – $2,137 = $625.

**For fun, compare the above chart to the chart for 8% earnings in my previous post, “Financial Advisors’ Commissions and Fees.” (Be sure to add a zero at the end of each amount in that chart. It’s based on $1,000 instead of $10,000.) You’ll be amazed at how a 3% increase in earnings affects the total amount of fees you’ll pay!  At 8% interest after 50 years, your $10,000 would earn $506,537, but you’d lose $203,198 in fees at 1%.

Copyright © 2010 Nancy K. Humphreys  All rights reserved. You are free to use material from Brucenomics in whole or in part, as long as you include attribution to Nancy K. Humphreys followed by a live link to http://www.brucenomics.com.

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4 comments ↓

#1 Raoul Martinez on 05.03.10 at 2:04 pm

Very interesting review of interest fees. I have several mutual funds, and frankly I don’t know what fees I am charged. (since I didn’t read the prospectus at the time we invested in these things.) What can I do to correct, if I find and feel that these fees are excessive?

#2 Nancy Humphreys on 05.04.10 at 10:51 am

Raoul, good questions! To find the expense fees charged for your mutual funds (or any other mutual funds you’re considering) go to http://www.morningstar.com. At the top of the page there’s a box that says “Quote.” Type the ticker symbol for your mutual fund in that box. Three rows below the fund name and ticker symbol you’ll see a string of information about that mutual fund. The basic fees for the fund are listed under the word “expenses.” The average mutual fund expense fee is currently 1.34%. See how yours compares.

What can you do as an individual to correct high fees? Buy mutual funds with lower fees! Vanguard is known for its lower fund fees, but not all of its mutual fund fees are low. Or find an independent financial advisor you trust and see if they can at least earn more for you to cover those fees. Or consider other kinds of investments.

Most important, keep on learning about investing. Take workshops through your local adult education or college extension programs, Learning Annex, brokerage firms or advanced programs like Investools and Robert Kiyosaki’s Rich Dad Poor Dad Academy. Read books about investing and biographies of famous investors. Read newspaper financial sections. Check out http://www.motleyfool.com.

Money, like friendships, gardens, and children, needs attention and caring to grow. Nancy

#3 Mary O'Sullivan on 05.04.10 at 11:36 am

My friend who is a CFP says much the same thing. Vanguard is one of the funds she consistently reccommends. I have, by the way, given her the link to your blog.

#4 Exchange Traded Funds (ETFs): The Safest or Riskiest Investment You Can Make? | Brucenomics on 05.16.10 at 1:08 pm

[...] my post, Fees in a Mutual Fund Prospectus: Three Ways A Prospectus Deceives, part 3,  we looked at how mutual fund fees can accumulate and take more than half of the total return on [...]

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