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The "Cost" of Owning an Actively Managed Mutual Fund
One of the major differences between index investing (i.e. ETFs and indexed mutual funds) and using actively managed funds is in annual fees and loads paid. Over time the combination of these two factors can cause the performance of an actively managed mutual fund to significantly lag behind a similar indexed investment. There are several cost advantages of indexed investing over actively managed funds including:
	Management fees: These fees are normally very low because the fund is designed to replicate an index. Very little research and active management is required.
	Trading costs: These costs are typically low, because trading is only required when new investors join, current investors leave or the index is reconstituted. Actively managed funds routinely buy and sell securities that incur trading costs.
	Other expenses: Expenses such as 12b-1s and shareholder services fees are typically not charged for index funds. ETFs, however, are subject to commission fees for each transaction. Frequent dollar cost averaging may generate ETF expenses that outweigh any cost benefit over a traditional indexed mutual fund.
	Loads: Most index funds rarely charge front-end or back end loads.
	Tax consequences: Taxable distributions are usually smaller in index products because they typically have lower turnover than the average actively managed mutual fund.
To display the effect expenses have on returns, a comparison of four similar investments have been made to the Standard & Poors 500 index. The S&P 500 index tracks the performance of approximately 500 large US stocks and is widely considered to be representative of the US stock market. The four investments are as follows:


Investment	Front End Load	Expense Ratio

ETF	N/A	0.11%

Index Mutual Fund	N/A	0.35%

No-load Actively Managed Fund	N/A	1.50%

Front-end load Actively Managed Fund	5.75%	1.50%

Provided for illustrative purposes only and should not be considered a recommendation or solicitation of any specific security.

The following assumptions were used in constructing this hypothetical:
	The beginning investment on December 31, 1969 is $10,000
	The time period covered is December 31, 1969 to August 31, 2003.
	Each investment’s return is assumed to have the same annual return as the S&P 500 index *before fees* are included.
	The annual expense ratio for each investment is subtracted from the return of the S&P 500 index each year.
	The expense ratio includes management, shareholder servicing and 12b-1 fees, but does not include commission fees.
	It is assumed the front-end load is withdrawn from the initial investment on December 31, 1969. The beginning value for the Front-end load Actively Managed Fund is $9,425.
	The expense ratios used are typical for the average fund in that particular investment category and does not reflect any specific fund family
Based on these assumptions the investments experienced the following hypothetical dollar growth from 1970 through August of 2003:

Conclusion

This hypothetical illustration displays the effect of expenses on the overall return of similar investments. In the case of index vs. active management investing the effect can be significant. In this example owning the actively managed funds cost the investor more than $100,000 over the period. The illustration proves that the expense ratio can significantly erode the return of a portfolio over time and ultimately the ending value.

Clearly, some actively managed funds do manage to outperform the market over time but most managers cannot do that consistently. Many investors are confused by the myriad of choices available in funds and it is difficult to pick the right mutual fund. It may be a great fund in previous years, but it more than likely will be an under performing fund in future years. Index investing affords you the following benefits:

	Index investing on average charges lower fees and expenses.
	Indexed investments typically distribute fewer capital gains than actively managed funds.
	Index investing is transparent – the investor can easily find their holdings.

All things being equal it always more preferable to pay smaller fees and not pay a load when investing. Indexed investing is a compelling investment strategy when the investor realizes he may have paid significant fees and found out he had significantly under performed their benchmark

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