|1.||Know what you're investing for.|
|2.||Make paying yourself a priority.|
|3.||Make tax-smart investments.|
|4.||Diversify your portfolio.|
|5.||Choose good investments.|
|>||Individual securities or mutual funds?|
|>||Index funds versus actively managed funds|
|>||Mutual fund expenses|
|>||Relationship between expenses and returns|
|>||Selecting a financial services company|
Are you focusing too heavily on the expense ratio of the funds you choose? It's far more important to look at the average annual total return of the fund, because this measures both how the securities in the fund performed and the effects of the fund's expense ratio.
Compare two hypothetical no-load mutual funds: Fund C and Fund D. Over the course of one year, the average annual total return of both funds is exactly the same, at 7%. Fund C, however, has an expense ratio of 1%, whereas Fund D has an expense ratio of 0.2%. Does this mean that shareholders in Fund D made more money than those in Fund C? No. The reality is that the securities in Fund C actually performed better than Fund D, earning an 8% return before expenses compared to a 7.2% return for Fund D. However, the average annual total return is the same.
A common investor mistake.Between Fund C and Fund D, which had better returns after expenses?
The answer is they both had the same returns after expenses. This chart represents how two funds' average annual total returns would typically be presented, with one-, five-, and ten-year returns. In comparing the performance of Fund C and Fund D, their average annual total returns were identical at 7%. While some investors place great emphasis on choosing funds with low expense ratios, average annual total returns of a fund are also critical to consider because they take expenses into account as well as performance.
As you can see, average annual total returns are inclusive of expenses. So when comparing fund performance, investors can look at the average annual total returns and know that they have already accounted for the effects of the fund's expense ratio. Of course, historical fund performance is only one consideration, and investors should determine how well a fund fits into their overall portfolio.