How Much Is That Basis Point Worth?

McQuarrie, Edward F.
August 2009
Journal of Financial Planning;Aug2009, Vol. 22 Issue 8, p58
Academic Journal
Mutual fund expense ratios and loads. along with adviser fees and wrap account charges, are among the many ways in which investors pay for investment management Unfortunately, to assess trade-offs between alternative fee arrangements expressed in fractions of a percentage point requires a facility with exponential series (that is, time value of money calculations) that too many investors lack To bring to the surface the land of misunderstandings to which investors all too often succumb, this article reviews such questions as: o Are low expense ratios generally more important in the case of stock funds or bond funds? o If paying a load earns a reduction in expense ratio, should the load be paid on ones stock funds or bond funds? If one financial planner charges an annual wrap fee, and another a one- time setup charge, what's the best way to compare total costs? The proper procedure is not to focus on the magnitude of the expense ratio in relation to the forecast returns, but to calculate dollar results for the two exponential series. All basis points are not created equal when they figure in exponential series. This is the dark side of what is sometimes referred to as the magic of compound interest. The higher the rate of return, the more costly a single basis point of additional expense becomes. Wrap fees can be far more expensive than they first appear.


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