At the Money: Why Fees Really Matter

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1:05Are fund fees going to zero? the trend for ETF prices has been lower fees. Now, after a decade of falling prices, those fees are approaching zero. Let's bring in an expert to help us unpack this. Eric Belchunas is senior ETF analyst at Bloomberg Intelligence, who writes about funds and ETFs for years. Eric, what's going on here with fees? Are they going to zero? Well, they have been for a while. There's already a couple zero-fee ETFs out there. They are from companies that aren't as popular as a Schwab or a State Street. So I think once you get below five basis points, you get to this realm of super dirt cheap where people don't really care.

1:50Are you three or four? Are you two or three? It's all almost free, basically. And for people who don't talk in basis points, one percent is 100 basis points. So we're talking about three basis points is 3 % of 1%. Yeah, so if you put$10 ,000 into the three basis point ETF, it'd be$3 a year. That's crazy. It is crazy. It's a beautiful thing. That is free. Yeah, it is. I call it the great cost migration. I call it the fee wars. This is why I call the ETF industry the terror dome, because it is brutal if you're an issuer. Everybody's cutting fees all the time. But the thing is, it works. Cutting fees almost is like batting 1 ,000.

2:31If you do that, the flows will come. So let's put a little history in place. Back in 2016, you wrote a column titled The Vanguard Effect, and the takeaway was the fee pressure the Vanguard Group was putting on Wall Street was saving investors a trillion dollars. Explain. Yeah, so if you say all the money that went to Vanguard, if Vanguard didn't exist, right, A lot of that money is going to be in mutual funds, which have an asset-weighted average fee of about 65 basis points. On an average fee, they're over 1%, but I like to asset-weight it to be fair. That just basically says, where are most of the assets?

3:07So 66. So if that money were in an average Vanguard fund, Vanguard's asset-weighted average is nine basis points. So that's a huge saving. So that money moving over there, if it weren't in Vanguard, we'd be paying 66 instead of nine. Then Vanguard only has half of the passive assets. The other half are people who copy them. BlackRock, State Street. Schwab. Even JP Morgan and Goldman now have Vanguard-esque. And Fidelity, that was the ultimate sort of surrender because Fidelity has been the active manager. But Fidelity has cheaper index funds than Vanguard now, and they advertise it. So it's amazing.

3:40So half of the other half, I kind of credit to Bogle or Vanguard. So if you add all that up, you're looking at a trillion dollars total. But that number grows by about$150 billion a year. And that number grows every year. So in the course of the next decade or two, we're going to look at$4 or$5 trillion in savings just from what Bogle and Vanguard did. That's unbelievable. And let's flesh this out. When Vanguard launched in 1974, mutual fund fees were what? 2%, 1.86%, some crazy number like that. Imagine that was it. There was hardly any competition. The fees were what they were. This has really been half a century of fee pressure.

4:17Yeah, so when I talk about how investors respond to lower fees, it happened with Vanguard too. Vanguard's first index fund was priced at 66 basis points, right around what mutual funds were, or the cheaper side. And over time, no one cared at first, because that was still kind of pricey. But over time, they kept cutting the fee because of the way their structure is. So when they got into the 2000s, they're now at 14, 12 basis points. Really cheap. Then they hit 2008, 2010, they go under 10. Once you get under 10, you're in like irresistible area. People go gaga for something that's got the single digit basis point fee.

4:51And why not? There's been major studies that show if you pay like a couple basis points over 30, 40 years, you get so much more of the compounding returns versus the asset manager. So why is this important? Why do a few basis points here or there matter? That can't possibly add up over decades, can it? It does. So when Bogle was trying to sell the index fund, everybody thought, oh, it's average. I don't want to be average. I don't want to be worked on by an average doctor. It was hard to sell average to the American public. We want winners. One chart he used that was very compelling, and I tell everybody, look, go look this up.

5:26It's a chart of the growth of$10 ,000 over 50 years. One of it makes 8 % a year, and the other makes 6 % a year. The 2 % would be the fees you pay the active fund plus the turnover and trading costs. The 8 % would be paying no fees. the no fees you get something like$360 ,000 the 6 % compounding only gives you like$170 ,000 almost double basically double and so when you put it in dollars and cents like that over time it really matters and to put that another way that that's 8 % that took 60 % of your total returns over those 50 years so with the with the no fee you get basically 98 % something like that of the total returns.

6:08Because remember, we're all here for one reason, compounding returns, the magic of compounding. And as those returns compound, the lower the fee is, the more that beautiful magic ends up in your pocket. And if you're talking about larger investment dollars, Vanguard put out a research piece some time ago that if you put up a million dollars and let it compound over 30 years, by the time you're at the end of those 30 years, that fee differential is about 30%. So if you start out with only 100, it's double. But just to talk in terms of percentage, it's not insubstantial after two or three decades.

6:48Yeah, absolutely. So the difference between paying like 80 basis points versus like eight is major. Now, when we get to eight to seven, it's a little less consequential. So that's why I say, do we need a zero fee ETF for fund? Not really. I think once you get below five, you're good. I don't think people, in fact, there's almost a case made that people sometimes repel from zero. They feel like it's a gimmick perhaps. Right. And so what we found is that if you look at advisor surveys, the two most important criteria for them in picking an ETF, number one is fee. Number two is brand. That's why we tend to see the money going to the big brands.

7:24let's say Vanguard, BlackRock, definitely, but also State Street, Invesco, Schwab. These brands, plus a low fee, irresistible. But if you take a brand that's not known for this, there was a company called FocusShares back in the day. They tried to undercut. Nobody really cared because nobody knew that brand and it felt gimmicky. So that's why I think the brand is also important here. It's not just the low fee. It's the low fee plus the brand. That is almost like an irresistible value proposition for most people. Let me throw a little bit of a curveball at you. We're talking about mutual funds and ETFs, but the reality is that's$20,$25 trillion.

8:01There's still another$50 trillion in equity and another, I don't know,$75 trillion in bonds behind that. How significant are ETFs and mutual funds to how people manage their assets? I think they're huge because in the end, consumers typically like convenience. If you make something more convenient, you're probably going to find some customers. And so to me, a mutual fund really pushed the envelope to make convenient. You give me your money and I'll take care of buying all the stocks. We'll get diversification going that way. We don't like have we don't pick one stock and it goes to zero. We lose all our money.

8:35We'll diversify and I'll manage it for you. The problem is the mutual fund structure isn't nearly as efficient or there's a multitude of reasons. The ETF structure, in my opinion, is a better vehicle to deliver what a mutual fund tries to deliver. Whether that's active, passive, or whatever, ETFs tend to be more efficient, tax efficient. They tend to be cheaper. You're able to get in and out them whenever you want. Mutual funds only one time a day. And they really fit nicely on brokerage platforms, which most people use. And so to me, ETFs are sort of the vehicle for the 21st century. I've often compared them to the mp3 uh whereas the mutual fund is kind of like a compact disc mp3 i don't i now can buy exactly the songs i want or if you stream um and you can have there's flexibility it fits on your phone better compact disc harder to you know lug them around so i think every industry goes through this i would also say an uber to the cab that's another industry uber uses the internet it's cleaner like some there's always these disruptive events and so etfs are big but But I got to say, ETFs at 80 basis points wouldn't be a big deal.

9:40They're only really popular in sweeping the country because they're cheap. And you have to give Vanguard and Bogle credit. That's where, even though he didn't like ETFs, he had this monumental impact on them. So to me, whether it's an index mutual fund or an ETF, the bigger trend is the great cost migration. And you got to go back to Bogle on that. That said, when it comes to getting investments in a low fee format, I think the ETF vehicle is the one most people prefer. Thanks, Eric. Really interesting stuff. Just a relentless pressure on prices. That saved investors trillions of dollars. But more importantly, we are aware of the impact of compounding.

10:2010, 20, 30 basis points makes a huge difference over time, especially if we're talking about decades. And so what lower fees mean is better performance over the long haul for investors. I'm Barry Ritholtz. You've been listening to Bloomberg's At The Money.

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