The Little Book of Common Sense Investing, Updated and Revised

Chapter FiveFocus on the Lowest- Cost Funds

The More the Managers Take, the Less the Investors Make.

NEARLY ALL FUND EXPERTS, advisers to investors, the financial media, and investors themselves rely heavily—indeed almost to the exclusion of other information—on selecting funds based on their past performance. But while past performance tells us what happened, it cannot tell us what will happen. Indeed, as you will later learn, emphasis on fund performance is not only not productive; it is counterproductive. Our own common sense, deep down, tells us: Performance comes and goes.

But there is one powerful factor in shaping fund returns, often ignored, that is essential to know: You can be more successful in selecting winning funds by focusing, not on the inevitable evanescence of past performance, but on something that seems to go on forever or, more fairly, a factor that has persisted in shaping fund returns throughout the fund industry’s long history. That factor is the cost of owning mutual funds. Costs go on forever.

Fund performance comes and goes. Costs go on forever.

What are these costs? The first and best known is the fund’s expense ratio, and it tends to change little over time. Although some funds scale down their fee rates as assets grow, the reductions are usually sufficiently modest that high-cost funds (average expense ratio of the highest-cost decile funds, 2.40 percent) tend to remain high-cost; lower-cost funds tend to remain lower-cost (fourth decile average ...