The S&P 500 Index Fund Hall of Shame

The S&P 500 Index Fund Hall of Shame

“Just buy the damn index fund.” -Jack Bogle

Indexing is an attractive investment strategy.  It usually offers a low-cost way of gaining exposure to a particular asset class.  Numerous studies have shown that cost plays a key role in the success of any investment strategy.

One simple way to evaluate the cost of a mutual fund is by looking at the expense ratio.  For the purposes of this discussion, we will ignore sales charges, load fees and tax efficiency.

Via Morningstar

The expense ratio is the annual fee that all funds charge their shareholders. It expresses the percentage of assets deducted each fiscal year for fund expenses, including 12b-1 fees, management fees, administrative fees, operating costs, and all other asset-based costs incurred by the fund.

In recent decades, technological advancements have made it possible for fund companies to offer index funds at a low cost to investors.  If an investor wants to participate in the S&P 500 by buying a mutual fund, they have plenty of options.  Vanguard, Fidelity and Schwab all offer S&P 500 index funds with expense ratios below 0.10%.

Buyer beware though, not all S&P 500 index mutual funds are created equally.  You might think that by now, all mutual fund companies would have come up with a way to offer their investors exposure to the S&P 500 index at a reasonable cost.  Not true.  In fact, there are many funds with downright, shameful costs.

Introducing the S&P 500 Index Fund Hall of Shame

Personally, I’d have a hard time stomaching paying anything over 25bps for an S&P 500 index fund.  ‘Tis the season though, so I’ll be generous and limit induction into this not-so-elite group to funds with an expense ratio above 0.50%.

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Do many people invest in these funds? Yup.  State Farm, Nationwide, Mass Mutual and Deutsche Bank are all household names.  The funds listed above have nearly $23 billion under management.

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To Blame or Shame?

I asked a friend of mine who works for a popular fund company (not State Farm) how they could possibly charge such a high fee for an S&P 500 index fund.

“I don’t think people realize they are overpaying.  Why shut the fund down if people are still willing to pay for it?”

That’s sad, but not an attitude exclusive to the fund industry.  If somebody is willing to pay a price for a service you offer, are you going to turn them down?  Probably not.  There are other issues though…

According to the State Farm website (emphasis my own):

Our main objective is to make each of our 15 State Farm Mutual Funds® a highly competitive and rewarding long-term investment for our shareholders.

State Farm Mutual Funds shareholders can feel confident that their investments are being managed in a responsible, conservative, and cost-effective manner consistent with a long-term perspective.

A “highly competitive”, “cost-effective” S&P 500 index fund with a 1.0% expense ratio.  Right.  Can you taste the snake oil?

Maybe you can’t blame a fund company for taking money from people “willing” to pay.  You can, however, shame them for being delusional enough to think they are offering a good product to their customers.

Shame.  Shame.  Shame…

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Tim Brennan

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